Monday, October 13, 2008

Ilargi: Let’s start with the essence of the misery, and get to the "money flows like wine" river from there. The insane credit injections and bank stock purchases we see pop up all over are largely a giant game of bluff.

With Germany putting 30% of its GDP into their "rescue", and Britain 20%, you don’t need to be a winner of a fake Nobel to understand that they’d better not be called on it. Well, those two might be able to bluff their way out of it, but a lot of the smaller ones will not.

And what exactly is the EU’s $2.2 trillion (Italy later today will round it off to $2.5 trillion) spent on? It goes towards propping up financial institutions that are insolvent. If not, they wouldn’t need it. Increased interbank lending makes none of them more solvent.

But even supposing that it will work for a while, what then? People have no money left, and no, their homes will not magically rise in value anytime soon. So to spend anything, they'd have to borrow. You really think that’s such a great idea, an economy based on credit that no-one can afford? Haven't we learnt a lesson by now? Can we still not tell where that will lead to?

Spain throws $135 billion at its banking industry. The largest bank in the country is Banco Santander, which is being reported to not be involved in subprime loans. Now, when I see a comment like that, I think of the 2.5 million housing units built in Spain over the past few years, and the 1.2 million that were never sold. And the $60 billion in aquisitions the bank has done lately, especially in the UK.

Now it wants to buy the biggest savings and loan in the US, Sovereign Bancorp. And the Madrid government puts money into that. Sounds brilliant to me. I guess the Spanish population is so shell-shocked by now, anything goes.

Remember the fight in Congress, and all the petititons, over the Paulson bail-out plan? Guess what, they're going to use the money for purposes that Congress never meant to give it for. Just like that. Paulson's Goldman bus-boy Neel Kash&Karry is going to buy direct stakes in banks, and not their casino toilet paper.

Which means the paper will still remain in the vaults, and the lies about the value can continue. And Congress signed away all oversight. Word is that the money will be put only into "healthy banks". Uh ... If they were so healthy, they wouldn’d need it, would they?

Another Goldman acolyte, Robert Zoellick, became the head of the World Bank after Paul Wolfowitz became too much of a profile risk. The World Bank is now taking it upon itself to "salvage" banks and economies in developing countries, together with the IMF.

Both institutions are of course, and have been for decades, nothing but US weapons designed to wage economic warfare in the poorer parts of the planet. They have never seen a crisis they didn’t like. Just watch what they’re going to do, and you will understand the true meaning of the term "disaster capitalism".

An interesting issue came to the surface today. With all these governments, spending trillions of dollars of taxpayers’ money, turning into large-scale owners of the banking industries in their countries, can the banks still proceed to foreclose on the homes the taxpayers live in? That would mean people now would have to pay to lose their homes.

Plus, of course, foreclosing is an expensive process for banks. Another cost for the same taxpayer. It gets better: the foreclosed homes would have to be sold, and since that always happens for -much- less than their "paper value", that brings down the value of neighboring properties even more. In those homes, too, live taxpayers.

France, Germany, and Spain committed 960 billion euros ($1.3 trillion) to guarantee interbank loans and take stakes in banks equal to 3 percent of their economies, racing to prevent the collapse of the financial system. The commitments came as Britain took majority stakes today in two of its biggest lenders and followed a pledge yesterday by European leaders to bolster market confidence as the global economy slides toward recession.

"What it should do is stabilize the banking system," said Peter Hahn, a fellow at London's Cass Business School and former managing director at Citigroup Inc. "Will it stop us from having a recession? No, nothing is going to stop us from having a recession." The agreement yesterday by heads of the 15 countries using the euro helped trigger a rally in stocks and the euro today after markets tumbled last week. The benchmark European equity index slumped 22 percent to its worst drop in two decades last week, before rebounding as much as 7.4 percent today.

In Germany, Chancellor Angela Merkel's government pledged 400 billion euros in loan guarantees and set aside 20 billion euros to cover potential losses. It will also provide as much as 80 billion euros to recapitalize banks, about 3.2 percent of the German economy, based on 2008 gross domestic product figures from the International Monetary Fund. The U.S.'s $700 billion package to buy toxic bank debt and possibly recapitalize banks is equal to 4.9 percent of GDP.

In France, President Nicolas Sarkozy said the state will guarantee 320 billion euros of bank loans and set up a fund that could spend up to 40 billion euros, or 2 percent of GDP, to recapitalize banks. Spain's cabinet today approved measures to guarantee up to 100 billion euros of bank debt this year and authorized the government to buy shares in banks in need of capital. Prime Minister Jose Luis Rodriguez Zapatero told a news conference in Madrid that no banks needed recapitalizing now and the measure was "preventative and precautionary."

Before Europe forged a common response to the crisis, Spain was one of several countries to produce unilateral measures to shore up banks, pledging to buy up to 50 billion euros of their assets. Britain wasn't formally part of last night's agreement because it doesn't use the euro, though Prime Minister Gordon Brown sat through the start of the meeting and presented measures already underway in Britain. Royal Bank of Scotland Group Plc, HBOS Plc, and Lloyds TSB Group Plc will get an unprecedented 37 billion-pound ($64 billion) bailout from the U.K. government, equal to 2.5 percent of the economy.

In exchange, Royal Bank of Scotland and HBOS will cede majority control to the government, give Brown seats on their boards, the right to halt dividends and power to limit executives' bonuses. RBS Chief Executive Officer Fred Goodwin and HBOS CEO Andy Hornby will also step down.

A band of Anglo-Saxon hedge funds have taken out large “short” positions on Santander, BBVA and other Spanish banks, betting the collapse of Spain’s property boom will inflict heavy losses on the whole financial sector

EU data shows that Philip Falcone, the US hedge fund baron who led the assault on HBOS, has sold short €138m (£108m) of Banco Popular’s shares, or 1.65pc of the total float, through his fund Harbinger Capital. He has short bets of €208m on Santander and €185m on BBVA. Blue Ridge Capital has targeted Bankinter and Popular. Calypso Capital Management, High Side Capital, Landsdowne, and Belgium’s Fortelus have all joined the hunt.

The Madrid positions are a way for funds to continue shorting banks in Britain, where Santander is now a key player after taking over Abbey National, Alliance & Leicester and Bradford & Bingley. Britain’s Financial Services Authority has suspended short selling of bank stocks, but Spain has not done so.

Mr Falcone, who earned $1.7bn last year from the US property crash, is not alone in questioning the Spanish banks. Morgan Stanley said a “momentous slowdown” is under way in Spain. It warned that Sabadell, Banesto and Popular were all extremely leveraged to the property bust.

Fitch Ratings has downgraded six sets of mortgage securities issued by Santander worth €4.06bn (£3.27bn). These loans were “sliced and diced” and packaged in an identical way to sub-prime mortgage bonds in the US. Many were based on mortgages that exceeded 95pc or even 100pc of the house value. The bank was unable to off-load many of these securities before the market froze.

The U.S. Treasury is seeking to buy equity in "healthy" financial institutions as part of a multibillion-dollar program designed to kick-start the flow of credit for consumers, a top Treasury official said Monday.

Speaking to a group of international bankers, Interim Assistant Secretary for Financial Stability Neel Kashkari said the U.S. is working "around the clock" on the program and detailed the steps Treasury is taking to put it in place. "We are moving quickly -- but methodically -- and I am confident we are building the foundation for a strong, decisive and effective program," Kashkari said.

He said the government's equity-purchase program will be voluntary, adding that it's designed with "attractive" terms to encourage banks in good financial health to participate. Kashkari's the point man overseeing the $700 billion rescue plan for the financial sector signed into law by President Bush earlier this month.

Teams at Treasury are working on purchases of mortgage-backed securities, whole residential mortgage loans, purchasing equity in banks, and compliance with the program, Kashkari said. "A program as large and complex as this would normally take months -- or even years -- to establish. We don't have months or years. Hence, we are working to implement the [purchase program] as quickly as possible while working to ensure high-quality execution," he said.

The Federal Reserve led an unprecedented push by central banks to flood the financial system with dollars, backing up government efforts to restore confidence and helping to drive down money-market rates. The ECB, the Bank of England and the Swiss central bank will auction unlimited dollar funds with maturities of seven days, 28 days and 84 days at a fixed interest rate, the Washington-based Fed said today. All of the previous dollar swap arrangements between the Fed and other central banks were capped.

Global economic leaders have redoubled efforts to unfreeze credit markets and avert the worst worldwide recession in thirty years after last week's 20 percent slide in the MSCI World Index. Policy makers from the Group of Seven nations pledged during the weekend to take "all necessary steps" to stem a market panic, and European governments are today announcing plans to avert a banking collapse across the region.

"Like high waves that have gathered tremendous pace, global policy initiatives are coming to crash on the markets' shores," said Alex Patelis, chief international economist at Merrill Lynch & Co. in London. "A turning point could be reached." The cost of borrowing in dollars for three months today fell to 4.75 percent from 4.82 percent, the highest this year. The rate for euros over the same timeframe declined to 5.32 percent from 5.38 percent.

On foreign exchange markets, the dollar dropped as much as 0.9 percent against the euro, declining to $1.3671. Stocks rallied worldwide and the MSCI World Index climbed 2 percent. "Taken together, the latest moves increase the chances that we will begin to see some relaxation of the intense funding stresses," Dominic Wilson and other economists at Goldman Sachs Group Inc. wrote in a note today. "This is because bank solvency risk should decline as the government offers protection."

As well as slashing interest rates in concert last week, global central banks are expanding their toolkits to push down money-market rates. The Fed on Oct. 7 said it will create a special fund to buy U.S. commercial paper and the ECB last week said it would offer financial firms unlimited euro funds. The Bank of England is scheduled to revamp its own money-market operations later this week. Until now, central banks and governments have failed to gain traction in markets, with investors criticizing them for adopting a scattershot and uncoordinated approach.

The ECB, the BOE and the Swiss National Bank "can provide U.S. dollar funding in quantities sufficient to meet their demand" into 2009, the Fed said today. The Bank of Japan may introduce "similar measures." The aim is to keep the financial system flowing with the world's reserve currency. Banks are hoarding cash for fear they will lose the money if it's loaned or held elsewhere, or because they need it for their own funding needs.

"Central banks will continue to work together and are prepared to take whatever measures are necessary to provide sufficient liquidity in short-term funding markets," the Fed's statement said. What began last December as a $24 billion arrangement between the Fed, the ECB and Swiss National Bank was ramped up over the past year to $620 billion and broadened to include central banks from the Norway to Australia.

Today's "action is unprecedented," said Neil Mackinnon, chief economist at ECU Plc in London and a former U.K Treasury official. Andrew Milligan, who helps oversee about $260 billion as head of global strategy at Standard Life, said it's a "much more important" move than the coordinated rate cut.

G-7 finance chiefs pledged Oct. 10 to take "urgent and exceptional action" after stocks plunged and as a global recession looms. European leaders yesterday agreed to guarantee new bank debt and use taxpayer money to keep distressed lenders afloat. Germany, for example, will provide as much as 500 billion euros ($681 billion) in loan guarantees and capital to bolster the banking system.

Royal Bank of Scotland Group Plc, HBOS Plc, and Lloyds TSB Group will get an unprecedented 37 billion-pound ($64 billion) bailout from the U.K. government. The U.K. stole a march on its counterparts by saying last week it would guarantee lending between banks and invest in lenders.

The U.S. Treasury today fleshed out its new proposal to buy stakes in financial firms. The program will be optional and aimed at "healthy firms," Treasury Assistant Secretary Neel Kashkari, who oversees the $700 billion rescue package, said in a speech in Washington. U.S. Treasury Secretary Henry Paulson has identified purchasing stocks as his top priority.

The collapse of New York-based Lehman Brothers Holdings Inc. precipitated the latest chapter of the 14-month crisis, causing banks to stop lending to each other out of concern they may not get their money back. The world's largest financial companies have posted more than $635 billion in writedowns and credit losses since the start of last year after the U.S. housing market slumped.

Today's move by central banks is "another welcome measure," said Ross Walker, an economist at Royal Bank of Scotland in London. "We'll have to see what comes out of it. We all expect more rate cuts, whether they're coordinated or not is another matter."

National governments around the world have agreed to do what is necessary to prevent another major financial institution from failing, the International Monetary Fund's managing director said, although he didn't specify any measures. During weekend meetings, the IMF's 185 member nations endorsed an earlier commitment by the leading industrial nations to "use all available tools" to prevent the failure of "systemically important" financial institutions. Essentially that meant "no one is going to let an important financial institution fail," said the IMF chief, Dominique Strauss-Kahn.

"It can be done in different ways, depending on different countries...But the fact that all the governments are now committed to do that is a very, very strong commitment, and I hope that the market will understand that," Mr. Strauss-Kahn said Saturday.Despite committing more than $1 trillion to rescuing financial institutions, national governments have been unable to restore confidence that they can contain deepening economic problems. The IMF meeting was another effort to build confidence and lift markets.

Although the meeting didn't produce a specific action plan, Mr. Strauss-Kahn applauded on Sunday the plan by the 15 nations that use the euro to issue guarantees and insurance and to buy stock in cash-strapped companies, and to issue qualifying capital to financial institutions, among other measures. He said he expected the 27-nation European Union as a whole to adopt the measures, too. "We have now a comprehensive response to the crisis, and I think that the market will reflect it," he said.

Privately, European officials have put the onus of the global financial problems on the U.S. They argue that markets know that Europe won't let institutions fail systemically now -- that Europe is reluctant ever to let any institution fail. The U.S. decision to let Lehman Brothers Holdings Inc. go broke, Europeans say, raised markets' doubts about U.S. resolve.

Since the Lehman failure, on Sept. 15, the U.S. has been trying to regain market confidence, and the Treasury Department is now clearing the way for the government to take stakes in significant financial institutions, rather than simply buying those institutions' illiquid assets. The Treasury had largely sold its $700 billion rescue plan as a way to purchase toxic assets.

Part of the problem in restoring market confidence is that national governments have often appeared to act in an ad hoc and uncoordinated fashion. While central banks from Europe and the U.S. recently agreed on a coordinated rate cut of half a percentage point, the finance ministries haven't been able to agree on similar, coordinated action.

Instead, actions by some countries to get a handle on their financial problems have sometimes worsened woes elsewhere. For instance, the Irish government's broad guarantee of deposits prompted investors in other nations to shift their money to Ireland. Recognizing the problem, the Group of 20 nations -- the big industrial nations plus China, Brazil and other powerful developing countries -- said at the IMF meeting that they are "committed to ensuring that actions are closely communicated so that the action of one country does not come at the expense of others or the stability of the system as a whole."

World Bank Chief Economist Justin Yifu Lin said there is a "consensus" among policy intellectuals internationally that "we are in a globalized world, financial flows are cross-border, and if we do not have a coordinated, systematic way to deal with this kind of issue, then it will be hard to restore confidence." That lesson has taken some time to be accepted in national capitals, he said, but he considered the coordinated rate cut a sign of the growing acceptance.

A big question is where the money is going to come from to help capitalize troubled banks. Late last year and early in 2008, sovereign wealth funds -- government-owned investment funds, with perhaps $3 trillion in total assets -- were buying large stakes in Citigroup Inc., Merrill Lynch & Co., Morgan Stanley, UBS AG and other Wall Street mainstays. The share prices of those firms have plummeted since then, making the funds more cautious about investing further.

The Abu Dhabi Investment Authority, widely regarded as the world's largest sovereign wealth fund, with perhaps $900 billion in assets, took a $7.5 billion stake in Citigroup in November. Hamad Al-Suwaidi, an ADIA director and undersecretary of Abu Dhabi's department of finance, left open the possibility that ADIA may make additional investments along those lines. "Proposals are coming in daily," he said. "We're evaluating our options with other financial institutions."

David Murray, chairman of the Australian Future Fund, said the fund was helping to bolster financial stability by buying "a very substantial quantity of bank bills" in Australia. "The money was too good to not back," he said. Messrs. Al-Suwaidi and Murray were in Washington for the IMF meetings to release a voluntary code of good conduct aimed at reducing concern that the funds might be acting for political motives. The 24 principles that the funds agreed on covered governance, operations and disclosure. Essentially, they were aimed at making clear that the funds were operating for commercial purposes.

While concern about the motives of the funds has dissipated as the search for global capital has intensified, they want to head off any nationalist backlash in the future. One principle, for instance, says that "relevant financial information" regarding a fund "should be publicly disclosed to demonstrate its economic and financial orientation." But the code is bound to be criticized as insufficient, because it doesn't ask funds to disclose their purchases, and there is no enforcement mechanism.

Also at the meeting, the International Finance Corp., the private-sector lending arm of the World Bank, said it is planning a $3 billion fund to capitalize small banks in poor countries affected by the financial crisis. While that is small change in the context of the U.S. and Europe, the fund is aimed at limiting the effects of the crisis in poor nations.

Germany will provide as much as 500 billion euros ($681 billion) in loan guarantees and capital to bolster the banking system, the country's biggest government intervention since the Berlin Wall came down in 1989. Chancellor Angela Merkel's government pledged 400 billion euros in loan guarantees, provided as much as 80 billion euros to recapitalize banks in distress and set aside 20 billion euros in its budget to cover potential losses from loans.

The rescue package will amount to about 20 percent of the gross domestic product of Europe's largest economy. Measures taken by the U.K. government and the Bank of England included emergency loans and lending guarantees totaling 500 billion pounds ($865 billion), about 30 percent of GDP. The U.K. government today provided an unprecedented 37 billion-pound bailout for Royal Bank of Scotland Group Plc, HBOS Plc and Lloyds TSB Group Plc. "We're taking measures in order to prevent a repeat of what we've just experienced," Merkel said following a cabinet meeting in Berlin today.

The government may influence management decisions and limit dividends at banks that get capital. It will also propose improving market supervision. Following today's approval by the cabinet, the rescue package is due to be ratified by Germany's two houses of parliament by the end of the week.

Germany's announcement follows an agreement yesterday by leaders of the 15 nations using the euro to guarantee new debt and use taxpayer money to protect troubled lenders. As part of the plan, the government said it will take "short-term" steps to guarantee so-called pfandbriefe, or covered bonds, while the Bundesbank pledged measures to ensure the liquidity of money- market funds.

The plan provides a "chance that short-term money markets will become liquid again and that the banking system may stabilize after all," said Konrad Becker, a Munich-based analyst at Merck Finck & Co. Stocks rallied worldwide today after European governments announced measures to shore up financial institutions and central banks pumped unlimited dollar funds into the money markets.

German banks, including state-owned lenders, have been increasingly hit by the world financial turmoil. The cracks in the system widened after Hypo Real Estate Holding AG needed a 50 billion-euro bailout as its Dublin-based Depfa Bank Plc unit, which lends to governments, failed to get short-term funding amid the credit crunch.

Altogether, Germany's seven state-owned Landesbanks have booked more than 15 billion euros in writedowns related to the collapse of the U.S. subprime mortgage market. "Extraordinary measures are necessary under such extraordinary market conditions," the Finance Ministry said in an e-mailed statement today. "The central task is to restore faith between market participants."

Shares in banks that are to be partially nationalised under Gordon Brown's £37 billion bail-out have plunged on the stock market. Despite the FTSE-100 rising, shares in HBOS had dropped another 25 per cent by midday, with Lloyds TSB having lost nine per cent and Royal Bank of Scotland (RBS) down 6.7 per cent. The banks have been ordered to stop paying dividends to shareholders until they are in a position to pay back the public purse.

Shares in Barclays and HSBC - the two banks which have made clear they do not need to take the Government's money - have risen, by 5.3 and 7.9 per cent respectively. Mr Brown earlier hailed the Government's plan to take large stakes in the three banks as proof that it will be a "rock of stability" during the financial crisis. Confirming that the Treasury will use billions of taxpayers' money to buy fresh capital, Mr Brown said: "The Government can not just leave people on their own to be buffeted about." "For savers, for small businesses, and for homeowners, we must in an uncertain and unstable world be the rock of stability on which the British people can depend," the Prime Minister told a Downing Street news conference. The FTSE-100 jumped by about five per cent within 10 minutes of trading - a rise it had maintained by the end of the morning.

The deal will see RBS take £20 billion of capital from the Government, effectively handing taxpayers a 63 per cent stake in the company. A further £17 billion is to be injected into HBOS and Lloyds TSB, meaning that if their plan to merge goes through, 41 per cent of the new "superbank" would effectively be owned by the public. Until then, the Government will take 58 per cent of HBOS and 30 per cent in Lloyds TSB. Mr Brown insisted that tough conditions had been attached to the deal and that taxpayers would get their money back. He said that none of the banks' directors would receive cash bonuses this year. Announcing that a new body would be set up to oversee the Government's stakes in the banks, he said that ministers would not be involved in running them.

"Over time we intend to dispose of all these investments in an orderly way. In the meantime, our shares will be held at arm's length," he said. Mr Brown added that the Government will appoint independent directors to the banks' boards - three to RBS and two to Lloyds TSB-HBOS should their merger go ahead. The chairman and chief executive of RBS - Sir Fred Goodwin and Tom McKillop and of HBOS - Andy Hornby and Lord Stevenson - will all step down, though Mr Brown insists the Government did not force this upon the banks. None will receive severance payments. The deal will also see RBS and Lloyds TSB-HBOS forced to raise their mortgage and small-business lending to 2007 levels - far higher than they currently stand.

Mr Brown said the "unprecedented but essential" move was "something that matters for every family and business in Britain." He added: "To let the chips fall where they may would be the height of irresponsibility." Describing the move as a reaction to "exceptional, extraordinary" times, the Chancellor, Alistair Darling, admitted that Government borrowing would have to soar to fund the deal. However he too insisted that taxpayers would get their money back. Mr Darling said that the intervention was a crucial step in the international fight-back against the financial crisis, and that other governments would now follow Britain's example.

"This is a model that other countries are going to adopt, because this is a truly global problem," he told BBC Radio 4. Angela Merkel, the German chancellor, is expected later to confirm a similar €470 billion (£373 billion) package to rescue German banks, while other European leaders have also agreed to formulate similar deals. The morning's developments also saw Lloyds TSB insist that its takeover of HBOS is still set to go ahead, despite continuing fears that it will collapse. However, it conceded that the deal will be done at a far lower price than had previously been expected, meaning bad news for HBOS shareholders.

The revised terms will see HBOS shareholders receive 0.605 Lloyds TSB shares for every one of their HBOS shares - down from an original level of 0.8.Meanwhile, Barclays has insisted that it will raise £6.5 billion in new capital itself and does not need the Government's help. As well as a cash call to the market, the bank will not pay a £2 billion dividend to its shareholders. HSBC last week injected £750 million of capital from its parent company into its British arm. A spokesman reiterated on Monday that it had no plans to use the Government scheme.

French President Nicolas Sarkozy says his government will provide up to €360 billion (US$491 billion) to help banks stay afloat through the financial crisis.

The measure is part of a raft of proposals agreed with other governments sharing the euro currency on Sunday to unblock frozen credit markets. Germany, Italy and others plan or have announced similar measures. Sarkozy says the money includes €320 billion ($436 billion) to guarantee bank refinancing and another €40 billion ($54 billion) for a government-backed financing vehicle to provide banks with the capital they need.

Sarkozy said the figure he announced Monday is a maximum, which may not be reached if the market starts functioning normally again.

Spain is to guarantee up to €100 billion (US$135 billion) in bank bond issuance this year, Prime Minister Jose Luis Rodriguez Zapatero said Monday. Zapatero said the measure agreed by the government Monday was in line with accords reached this weekend in Paris on ways to tackle the financial crisis.

The measure would guarantee credit operations by Spanish banks to the end of this year. Foreign banks "with significant operations in Spain" are also to be covered, he added. Zapatero said the amount for 2009 had yet to be studied. The credit operations covered include treasury and debenture bonds as well as securities.

He said the European Union's coordinated efforts were "the best guarantee for maintaining employment and social security."Zapatero said the Spanish government had also approved the possibility of recapitalizing banks but had no need to do this now as its banks were in good shape. He said the government would guarantee debt issued to the end of 2009 with maturities up to a maximum five years.

Under Spanish law, state guarantees have to be approved by Parliament each year, Zapatero told a news conference. Last week Spain approved a €30 billion (US$41 billion) fund to buy assets from banks starved of liquidity. The government said the measure would not cost Spanish taxpayers anything as the government will buy only quality assets, not bad mortgage-related debt as Washington has done in its huge bank rescue plan. It will also be able to resell the assets once financial markets settle down.

The government also raised Spain's bank deposit guarantee limit from euro20,000 (US$27,000) to euro100,000 (US$137,000).One of Europe's biggest stories over the past decade, Spain's economy has stumbled badly over the past year, due largely to a collapse in its key construction industry and tighter credit policies at banks. But Spanish banks are considered to be in relatively good shape compared to their European and American counterparts, having avoided most of the sub-prime mortgage crisis and the collapse of mortgage-backed securities that have imperiled other financial giants.

After days of losses, Spain's Ibex 35 stock market index was gaining more than 7 percentage points Monday. On Monday, some 100 people protested outside Spain's central bank headquarters calling for the government to investigate why banks here sold bonds from collapsed U.S. investment bank Lehman Brothers to thousands of low risk profile investors without mentioning the risks involved or that they belonged to Lehman

The United States needs a new economic stimulus plan that pumps billions of dollars into infrastructure projects and budget relief for cash-strapped state and local governments, Democratic lawmakers said on Sunday.

U.S. Rep. Barney Frank, chairman of the House Financial Services Committee, told ABC television he will put together an economic stimulus bill when Congress returns to Washington after the November 4 elections, while a key Republican said he would support an effort that "makes sense."

Rep. Roy Blunt, the Missouri Republican who serves as House minority leader, said he would support a stimulus plan if it did not include massive public works spending and budget bailouts for states that overspent on health care and other social programs.

"A stimulus plan that makes sense is something that I'll be helpful with," Blunt said, also on ABC television.U.S. House Speaker Nancy Pelosi last week said a $150 billion economic stimulus plan was needed to help counteract a faltering economy shaken by a paralyzed banking system and steep stock market falls.

On Monday, Pelosi and House Democratic leaders will meet with key economists to discuss a jobs creation and recovery plan that will complement the recently passed $700 billion rescue legislation for financial institutions. Participants will include former U.S. Treasury Secretary Larry Summers, former Securities and Exchange Commission chairman Arthur Levitt and former Federal Reserve vice chairman Alice Rivlin.

The Congress earlier this year passed a $152 billion stimulus package that provided tax rebates of up to $600 per adult to support consumer spending at a time of rising energy and food costs. Most of that money has already been spent, and many economists say financial turmoil will squeeze the economy into recession in the fourth quarter.

"Not only is Wall Street frozen, but Main Street is in real trouble. A stimulus aimed at Main Street makes sense," New York Sen. Charles Schumer told CNN. He said the plan should "get into the guts of the economy" by boosting spending on infrastructure such as roads, sewer and water projects.

Former Treasury Secretary Robert Rubin, who served under President Bill Clinton, told CNN that an infrastructure plan that could quickly pump money into the economy was the most important action that U.S. authorities could take to help deal with the current economic crisis.

"I would put in place an infrastructure piece... bridges, water systems roads, highways, but not new projects that are going to take a long time to set up," Rubin said. "There are a lot of existing projects where states and cities are having a hard time finding a lot of financing where you could funnel that money right into existing activities where you would be able to act very very quickly."

Schumer also urged the Treasury to move quickly on its plan to buy equity stakes in banks. "I am hopeful that tomorrow the Treasury will announce that they're doing it. And they have to do it quickly," said Schumer, a New York Democrat. "This cannot be two, three, four weeks. The markets are waiting, the country is waiting, and we're beginning a downward spiral, not just in finance ... but in the whole economy. We need quick action," he added.

World finance and development ministers warned on Sunday that developing countries risked serious and lasting setbacks from the global financial crisis and urged major economies to deliver on aid pledges. "This is a man-made catastrophe," World Bank President Robert Zoellick told a news conference after a development committee meeting of IMF and World Bank member countries.

"The actions and responses to overcome it lie in all our hands," Zoellick added. World finance leaders on Sunday endorsed an action plan by major economies to chart a course out of the crisis, which began in the U.S. housing market and soon spread to Europe, triggering the most severe downturn in years.

In a communique, the development committee called on the World Bank and its sister organization, the International Monetary Fund, to draw on the full range of their resources to help countries that may encounter problems, not only from the credit crisis, but also from high food and fuel prices. "The poorest and most vulnerable groups risk the most serious -- and in some cases permanent -- damage," the development committee communique said.

The World Bank said it has the capacity to "comfortably double" lending to developing countries in need. IMF Managing Director Dominique Strauss-Kahn repeated that the Fund stood ready to respond with a $200 billion war chest. Ministers also urged the World Bank to explore all options to help recapitalize banks in developing countries affected by the global liquidity crunch.

The bank's private-sector lender, the International Finance Corp, said on Saturday it planned a $3 billion fund to help small banks hit by the financial crisis. But ministers said big donor nations should not use the turmoil in markets as an excuse to pull back on aid promises to the poor. African finance leaders pointed to the speed with which the U.S. and Europe have raised billions of dollars for faltering banks but are behind in aid commitments to poor countries.

Higher food and fuel prices have added to the budget squeeze of poor countries. The World Bank has a watch list of 28 countries facing financial strains which spans from Jordan, Lebanon, Cambodia, Sri Lanka to Jamaica, Haiti, Ethiopia, Rwanda, Malawi, Nepal, Fiji and Ivory Coast. "We must ensure that as governments and the public turn their attention close to home, they do not step back from their commitments to boost assistance," Zoellick said. "Aid flows must be maintained (and) today's meeting of ministers was unanimous in that regard," he added.

European Union aid officials also worry. "The credibility of the donor community as a reliable partner is clearly at stake," Louis Michel, the EU's aid chief, told the development committee. "This is already self-evident when the fledgling pace with which aid for the poorest is increased is compared with the speed with which aid for the richest is mobilized," he added.

U.S. Treasury Secretary Henry Paulson urged the World Bank and IMF to make every effort to ease the impact of the financial crisis on poorer countries because he said they ultimately will be affected. "Financial market developments are having an acute impact on advanced countries, and we can expect the crisis to have major ramifications for emerging markets and the poorest countries as well," he said.

International development group Oxfam said it was disappointed with the outcome of Sunday's development meeting. "This weekend's meeting offered shamefully few solutions for the world's poorest countries. World Leaders acknowledged there is a global poverty crisis, but they failed to address it," Oxfam spokeswoman Marita Hutjes said.

Global advocacy group, the One Campaign, said: "The world's leading economies should not open the door to a solution to the financial crises whilst shutting the door to progress for the world's poorest countries." Developed countries promised to double aid to Africa by 2010 at a leaders' summit in 2008, but have failed to make good on the pledges. Strains on poorer countries have become especially acute as prices for food and fuel have risen sharply.

Although the prices have declined somewhat, they remain high in historical terms and are likely to stay volatile. Rising food prices have caused 75 million more people to go hungry, the Food and Agriculture Organization said. Similarly, the World Bank has said food price increases may swell the ranks of the world's poor by 100 million people.

Gordon Brown has been told by the Labour party's biggest donor, the Unite union, that customers of nationalised banks who default on mortgage payments should not have their homes repossessed. The Government now has significant share holdings in four High Street banks - Royal Bank of Scotland, HBOS, Bradford & Bingley and Northern Rock - after the taxpayer-funded bail-out.

Derek Simpson, the joint general secretary of the Unite union, upped the pressure on the Government by insisting that customers of the four "people's banks" should be treated differently. He said: "The measures announced today must be bound to undertakings by the banks of no job losses, no repossessions and an end to the bonus culture." Mr Simpson's remarks will have extra resonance because the union is the party's biggest single donor. In the three months to the end of June, it gave £1.5million - amounting to 41 per cent of the party's which accounted for £4 out of every £10 donated to the party in the three months to June.

He added: "Thatcher buried Keynesian economics and the current crisis shows just how wrong she was. "Government intervention is not only necessary in the financial services but intervention on a wider scale is necessary to protect jobs and the economy in a recession. "Workers in the financial services industry are not the culprits of the credit crunch and we are not prepared to allow them to become the victims. "The taxpayer must now get a firm assurance that the financial lifeline extended to these large organisations will be used to protect jobs and the public. "It is not acceptable for the government to socialise the risk without allowing the wider society to capitalise on the rewards in the finance industry."

A spokesman insisted last night there was "no connection" between the union's donations to the Labour Party and its public pronouncements. He said: "This is not a gun to the head." Matthew Elliott, Chief Executive of the TaxPayers' Alliance, said: "This is Alice in Wonderland economics. Unite have criticised banks' unsustainable business models, but a proposal to ignore defaulting mortgagees would be far worse. "The banks and taxpayers are in trouble as it is, but this would be carte blanche for millions of people just to stop paying their mortgages. "Abolishing the fundamental logic of the housing market and the banking system would be an act of lunacy."

The Icelandic assets seized by the UK Government under anti-terror laws are more than enough to pay back British savers caught up in the country's banking collapse. At least £4bn is thought to have been frozen in the immediate aftermath of the collapse, £1bn more than councils, charities and individual savers stand to lose.

The decision to invoke anti-terror laws was described by the Icelandic Prime Minister, Geir Haarde, as a "completely unfriendly act". But the news that the British Government looks capable of paying off any losses with seized assets appeared not to have calmed local councils, many of which have invested millions of pounds in Icelandic saver accounts.

This week representatives of local authorities which have invested hundreds of millions of pounds in investment banks will meet the Icelandic ambassador in the hope that they can win assurances that their investments in the bankrupted country will be repaid. The Local Government Association (LGA) said an estimated 108 councils had deposited almost £800m in Icelandic banks. The LGA has already had a meeting with the British Government and won a promise that authorities facing severe short-term difficulties will receive assistance.

Fears have been raised by unions that some councils may have used Icelandic accounts to hold payroll. Although no council has admitted salaries are at risk, Braintree in Essex is thought to be one council in such a position. Unison, which represents local government workers, has written to the LGA expressing "grave concern" about any salary shortages that may possibly result from the collapse.

Meanwhile, the billionaire businessman Sir Phillip Green looks set to invest up to £2bn in a troubled Icelandic retailing group that owns House of Fraser, Karen Millen and Hamleys. Sir Philip has held talks with the Icelandic government about buying debt from the retailing group Baugur, thought to have lost over £1bn in the crisis. Sir Philip, who owns Bhs and Topshop, described Baugur as "fundamentally sound".

The tycoon criticised the "barrage" of negative news in the media, which he described as "fundamentally unhelpful" to Britain's economic recovery. "We have not yet seen significant corporate collapse," he said. "We haven't seen significant unemployment. Do I think there are pressures in the economy? Of course. But if we keep frightening everybody it will feed on itself."

Now that Hank Paulson has recognised that the troubled asset relief programme is best used to recapitalise the banking system, it is important to spell out exactly how it should be done. Since it was not part of the Treasury secretary’s original approach, there is a real danger that the scheme will not be properly structured and will not achieve its objective. With financial markets on the brink of meltdown it is vital to make the prospects of a successful recapitalisation clearly visible.

This is how Tarp ought to work. The Treasury secretary should begin by asking the banking supervisors to produce an estimate for each bank, how much additional capital they would need to meet the statutory requirement of 8 per cent. The supervisors are familiar with the banks and are aggressively examining and gathering information. They would be able to come up with an estimate in short order provided they are given clear instructions on what assumptions to use. The estimates would be reasonably reliable for the smaller, simpler institutions, but the likes of Citibank and Goldman Sachs would require some guesswork.

Managements of solvent banks would then have the option of raising additional capital themselves or turning to Tarp, which would state the terms on which it is willing to underwrite a new issue of convertible preferred shares. (Convertibles are better than warrants because the banks should not need additional capital infusions later.) The preferred shares would carry a low coupon, say 5 per cent, so as not to impair banks’ profitability. The new issues would dilute existing shareholders but they would be given preferential rights to subscribe on the same terms as Tarp and if they were willing and able to put up additional capital they would not be diluted. The rights would be transferable and if the terms were set right, other investors would take them up.

Using this approach, $700bn should be more than sufficient to recapitalise the entire banking system and funds would be available to buy and hold to maturity mortgage related securities. Since insolvent banks would not be eligible for recapitalisation, the Federal Deposit Insurance Corporation would certainly require topping up.

Concurrent to the recapitalisation scheme the authorities would lower minimum capital requirements so that banks would compete for new business. The Fed would also guarantee interbank borrowing by banks eligible for recapitalisation. This would reactivate the interbank market and return the spread of Libor over Fed funds to normal and reduce the abnormally high interest rates on business and mortgage loans linked to Libor.

The success of the bank recapitalisation programme could be undermined by a downward overshoot in housing prices. A separate set of measures is needed to keep foreclosures to a minimum and to fundamentally restructure the deeply flawed US system of mortgage finance. Taken together the two sets of measures would not prevent a recession – too much damage has been done to the financial system and the general public has been traumatised by the events of the past few days – but they would reduce its duration and severity. Once the economy returns to normal, the minimum capital requirements of banks would be raised again.

The international financial system also needs repairing but there are grounds for optimism. Europe has realised that it needs to complement the euro with a government safety net for interbank credit. And the International Monetary Fund is finding a new mission in protecting countries at the periphery from the storm at the centre.

The recapitalisation scheme outlined here would suffer from none of the difficulties of reverse auctions for hard-to-price securities. It would help restart the economy and likely produce returns for taxpayers comparable to my fund’s. But time is of the essence. The authorities have lost control of the situation because they were constantly lagging behind events. By the time they acted, measures that could have stabilised markets were ineffective. Only by promptly announcing a comprehensive set of measures and executing them vigorously can the situation be brought under control.

Actions speak louder than words. Specifically, Morgan Stanley urgently needs rescue. The Treasury should offer to match Mitsubishi’s investment with preferred shares whose conversion price is higher than Mitsubishi’s purchase price. This will save the Mitsubishi deal and buy time for successfully implementing the recapitalisation and mortgage reform programmes.

In what could set an important precedent, federal officials assured a big Japanese bank late Sunday that its planned investment in the embattled Wall Street giant Morgan Stanley would be protected, according to people involved in the talks.

After two days of tense negotiations, Treasury officials urged a hesitant Mitsubishi UFJ Financial Group to proceed with its $9 billion investment in Morgan Stanley, which has sought the capital infusion to reassure investors and customers about its stability. The deal is considered a crucial step in the government's strategy for revitalizing the financial system by luring outside investment while it considers buying stock in banks directly. The transaction's failure would deal a blow to that effort and potentially unnerve the markets.

The Treasury's assurances amount to another extraordinary move by government and could serve as a model for future deals.Mitsubishi and the Japanese government pressed the Treasury Department over the weekend to guarantee that if the United States were to inject money into Morgan Stanley at a later time — a step the Treasury has ruled out for now — the move would not wipe out Mitsubishi's investment. Officials from the Treasury declined to comment Sunday night.

Mitsubishi was pressing for more favorable terms after Morgan Stanley lost nearly half its market value during the stock market plunge last week. Analysts estimate that Morgan Stanley has more than $100 billion in capital, but the firm has struggled to regain investors' confidence since the collapse of Lehman Brothers last month.Last month, Mitsubishi agreed buy about 21 percent of Morgan Stanley. The investment was to be made in the form of $3 billion in common stock, at $25.35 a share, as well as $6 billion in convertible preferred stock with a 10 percent dividend and a conversion price of $31.25 a share.

Under the proposed new terms being discussed on Sunday night, Mitsubishi would still buy roughly 21 percent of Morgan Stanley, according to people involved in the talks. But all of the investment would be through preferred shares, with a 10 percent annual dividend. Many of those shares would be convertible into common stock, but the Japanese bank was trying to set a conversion price far lower than originally proposed, probably close to $20.

Morgan Stanley revised the terms of its $9 billion investment from Mitsubishi UFJ Financial Group Inc., providing the Japanese bank with preferred stock that pays a 10 percent dividend instead of common stock. Mitsubishi UFJ, Japan's biggest lender, will get 21 percent of the New York-based company as previously agreed, the two firms said today in a joint statement. The terms were renegotiated because Morgan Stanley's stock price fell 60 percent last week. The transaction closed today.

Morgan Stanley Chief Executive Officer John Mack is trying to regain investor confidence after the stock dropped last week to a 13-year low of $9.68, 62 percent lower than the price at which Mitsubishi UFJ had agreed to pay for the company's common stock. The stock decline had ignited concern the transaction wouldn't be completed, jeopardizing Morgan Stanley's credit rating. Morgan Stanley shares jumped as much as 29 percent before the opening of the stock market in New York.

"Despite a very challenging environment, MUFG and Morgan Stanley have demonstrated our mutual commitment to this strategic alliance and have revised the terms of our investment in the best interests of both companies and our shareholders," Nobuo Kuroyanagi, Mitsubishi UFJ's president and CEO, said in today's statement. Under the revised deal, Mitsubishi UFJ will get $7.8 billion of convertible preferred stock that will convert to stock at a price of $25.25 per share, down from $31.25. The rest of the investment will be $1.2 billion of non-convertible preferred stock. Both classes of stock pay a 10 percent dividend.

"The global news isn't good yet, and investors will continue to question and focus on renegotiating deals where they can," said Tom Murphy, managing partner at Family Office Research & Management Ltd. in Sydney. "Japanese capital will be a significant player in this crisis, and it won't be shy capital when it comes to deal-making."

Treasury Secretary Henry Paulson said Oct. 10 that the government will buy equity in a "broad array" of financial institutions to restore market stability and ensure economic growth. Federal officials assured Mitsubishi UFJ late yesterday that its investment in Morgan Stanley would be protected, the New York Times reported, citing unidentified people involved in the talks.

George Soros, the billionaire chairman of Soros Fund Management, wrote in the Financial Times today that the U.S. government should buy preferred stock in Morgan Stanley that converts to shares at a price above what Mitsubishi UFJ agreed to pay. Closing the investment from Mitsubishi UFJ will be "critical" for Morgan Stanley to keep its current credit ratings, Moody's Investors Service said in a statement on Oct. 9, when it placed Morgan Stanley's A1 long-term debt rating on review for downgrade.

Mitsubishi UFJ is the second overseas investor to take a significant stake in Morgan Stanley. In December, China Investment Corp. paid $5.58 billion for equity units in Morgan Stanley that pay 9 percent a year and convert to common stock in 2010, granting CIC about 10 percent of Morgan Stanley. Moody's in August cut Morgan Stanley's long-term credit rating from Aa3. At A1, the firm now has the fifth-highest investment-grade rating.

Today, Morgan Stanley closed its investment from Mitsubishi UFJ. The investment was revised downward after a brutal week in which rumormongers attacked Morgan Stanley — and its stock– enough to raise doubts about the firm’s capitalism. With market sentiment out of control, the bank moved to close the deal a day earlier than expected. Below is the full text of John Mack’s memo to Morgan Stanley employees about it.

To: All EmployeesFrom: John Mack

I am pleased to let you know that we have officially closed today on our $9 billion equity investment from Mitsubishi UFJ Financial Group (MUFG) – a day earlier than expected. This investment further strengthens our capital position and gives us a powerful strategic partner going forward.

Under the terms of the deal, MUFG is investing $9 billion in exchange for a 21 percent interest in Morgan Stanley, as agreed in September. MUFG is acquiring $7.8 billion of perpetual non-cumulative convertible preferred stock with a 10 percent dividend and a conversion price of $25.25 per share, as well as $1.2 billion of perpetual non-cumulative non-convertible preferred stock with a 10 percent dividend. This investment is a win-win for both companies, and we are honored to welcome MUFG as a long-term investor and strategic partner.

MUFG and Morgan Stanley are working toward numerous areas of collaboration, including pursuing a lending relationship, and we are confident that the combination of these two world-class institutions creates a powerful global alliance in the current challenging market environment. Indeed, this strategic partnership will bring together Morgan Stanley’s global investment banking and asset management expertise with MUFG’s vast resources and significant expertise in retail banking to better serve clients worldwide.

This alliance also is a key step in Morgan Stanley’s transition under our new bank holding company status. MUFG is the world’s second largest commercial bank with $1.1 trillion in assets, and their support and insights will boost our efforts to grow our deposit base and expand our retail business – leveraging the many advantages Morgan Stanley currently has. As you know, we already have two deposit taking institutions with total deposits of $36 billion – and the Firm will be looking to grow those deposits over time. We also have 8,500 financial advisors and almost 500 branches, which the Firm can use to expand the retail banking products and services we offer our clients. We also will be looking at acquisitions that might make sense for the Firm and help us ramp up our deposit base.

Today’s investment further bolsters Morgan Stanley’s strong capital position – and boosts our Tier 1 Capital Ratio to more than 15.5 percent, on a pro-forma basis as of August 31. This is more than double the 6 percent required by the Federal Reserve to be treated as well-capitalized and is one of the highest Tier 1 Capital Ratios among bank holding company peers. This investment also will reduce Morgan Stanley’s leverage ratio to under 20x and its adjusted leverage ratio to just over 10x, on a pro-forma basis at August 31. The fact is that our capital and liquidity positions remain strong, as we made clear in our 10Q filing on Thursday and as numerous financial analysts made clear in their reports last week.

These are truly unprecedented times, and I know the last few weeks have been difficult for all of you. Tough times like this test people, and the people of Morgan Stanley have risen to the challenge. You have continued to serve our clients and build our business, and I am incredibly proud of how the Firm has responded to these challenging markets. MUFG’s investment is a powerful endorsement of the tremendous value in the Morgan Stanley franchise, but the caliber and commitment of our people give me even greater confidence about the future of this Firm. Thank you all for your continued hard work, focus and dedication.

The biggest companies in the US car industry, brought to the edge of bankruptcy by the economic turmoil, are considering extraordinary new plans to save themselves, including mergers that could throw tens of thousands of workers out of their jobs.

General Motors, the largest US car manufacturer, has talked in recent weeks with rivals Ford and Chrysler about combining forces with one or other of them, in the hope of finding the massive new cost savings that are required to make up for plunging sales. Talks to take over Chrysler have stalled because of the panic on the markets in recent days, but are expected to resume quickly. Any deal would dramatically reshape the industry and the companies' native Detroit, the Motor City, whose slide has become emblematic of America's industrial decline.

The crisis in Detroit has become more acute with each day of the credit crunch, since all three major car makers are relying on the debt markets to tide them over amid spiralling losses – and investors doubt their ability to survive. Meanwhile, consumers who usually buy new cars using loans arranged at the showroom are finding that only those with the very highest credit ratings can get loans. Sales are at their worst level since the early Nineties.

General Motors is worth less than it was going into the Great Depression in 1929. Rival Ford halved in value last week. Shareholders are likely to be wiped out if the companies plunge into bankruptcy. Amid the tumult, it has emerged that GM has been holding talks with Cerberus Capital, the private equity firm which owns Chrysler, about taking over Detroit's No 3 car maker.

The two companies employ 130,000 people, mainly in Michigan, which has one of the worst rates of unemployment and declining house prices in the country. John McCain pulled his campaign staff from Michigan, ceding the state to Barack Obama, who is far ahead on the issue of the economy. GM and Chrysler are haemorrhaging money, despite cutting 100,000 jobs since the start of the decade. GM lost $15.5bn in three months, according to its latest results, and has promised more production cuts across the world.

It has been trying to take on new debt, using buildings as collateral, but the debt markets are frozen. Ford has even less room for manoeuvre, after having already mortgaged most of its assets last year, including its blue oval logo.

Cerberus only bought Chrysler 18 months ago from the German firm Daimler. It had expected the company to return to profit next year after a deal with unions that offloaded billions of dollars in healthcare promises and cut new employees' wages. All the big US car makers pay billions per year in pension and healthcare benefits to retired employees from their heyday. In the past year, Toyota has overtaken GM as the world's best-selling car company.

The distress has been compounded by soaring petrol prices causing a slump in demand for SUVs and pick-up trucks. The credit crisis has proved the last straw. Cerberus is reportedly offering Chrysler for sale. GM would be best placed to extract cost savings by combining plants and axing competing models. "It will mean job cuts," said Tim Ghriskey of Solaris Asset Management.

Negotiations between GM and Chrysler come after talks between GM and Ford. GM is losing $1bn a month and although it has enough cash to survive the year, credit rating agencies have promised to downgrade its debt on fears for 2009 unless dramatic action is taken. Such a downgrade could kill the company. Ford, facing a similar downgrade, has been trying to sell its stake in Mazda, the Japanese car maker.

The roar was visceral: a gutsy grunt of defiance. For a few heady minutes on Friday afternoon, traders on the floor of the New York Stock Exchange cheered aloud as they briefly heaved the stock market into positive territory. The effort was Herculean: a dwindling band of optimists pouring billions of dollars into a few selected shares in the hope of encouraging others to rally round. Twice they succeeded, only to see the forces of panic overwhelm them each time.

Finally, New York closed for the weekend, once again in the red: bringing temporary relief to a global rout that has reduced the value of most international markets by a fifth in just five brutal days. Listening to the animal language of the trading pit, it is easy to forget that securities trading is just a mathematical invention – nothing but the abstract agglomeration of pricing data. The sober Reuters wire service wrote on Friday of investors being “castrated”. Scandinavian bank Enskilda warned clients that markets were “at riot point”. “It’s like someone cancelled gravity yesterday,” added one London trader.

Goldman Sachs boss and Wall Street cheerleader Lloyd Blankfein spoke of “unlimited pessimism”. Surely no mere human construct can behave so uncontrollably? The sense that humanity is instead grappling with a monster – a marauding Godzilla leaping from Tokyo to London then Wall Street, in single bounds – is compounded by the apparent failure of both national and international rescue attempts. It feels an age since the US and UK governments each committed £400,000,000,000 of our money to bailing out the markets: the euphoria that followed lasted barely hours.

Hopes that the G7, IMF or EU will do much better this weekend are almost as low as the markets themselves. Our biggest guns are bouncing harmlessly off this force of nature. For many bystanders, the drama is compelling. Newspapers and TV channels report the crisis much as they did Hurricane Katrina or the Indonesian tsunami: a mixture of shock, awe and lots of computer-generated graphics. We know in our hearts that this will hurt us all, but the lingering feeling that the world has changed for ever in just 30 days leaves us giddy.

The anxiety is also contagious. No matter how secure one’s personal finances, it is impossible not to feel a frisson of panic at the thought that bank ATM machines might run out of cash, or pay-cheques might vanish into the ether: both very real prospects until the Government stepped in to underwrite the bank clearing system on Tuesday. Even now, there are scenarios so destabilising they are barely mentioned. Our fear explains why Friday’s sell-off was so brutal. This delayed reaction to a month of almost unbelievably bad news in the credit markets was driven primarily by ordinary investors – Mr & Mrs Average finally deciding to cash in their pension nest egg for fear it might be cracked beyond repair by Monday.

All round the world, fund managers reported a huge surge in customers demanding their money back. The professionals panicked long ago. Ironically, the worst of the financial crisis may, just possibly, have passed. Friday also exhibited many of the hallmarks of what market historians call “capitulation” – the moment when even the optimists lose hope. The sad lesson of past stock-market crashes is that the point when ordinary punters finally realise it is time to get out usually marks the point when it is time for the smart money to get back in again. But the difference now may be in what happens beyond the financial markets. Usually, a banking crisis follows some form of economic crisis: lenders are hit by wave after wave of customer bankruptcies until they themselves cannot take any more and topple over. This time, the banking collapse has preceded the recession.

Although the crisis started with the default of some sub-prime mortgages in the US, the scale of the global market losses (and government bail-outs) long ago exceeded the size of the initial defaults. Instead, last week’s stock market rout marked the point when the usual direction of cause and effect was reversed: now it is the real economy that is expected to take its cue from the markets. Countries could be next to see their solvency questioned. Iceland is already seeing its currency under attack. Difficult places such as Pakistan, Ukraine and Kazakhstan are looking vulnerable – with devastating consequences for political stability.

Even Britain and the US are seeing the price of credit protection soar as investors worry whether they can afford to bail out the banking system. Then there is the commodity boom. A bubble in the market for oil is coming to an equally abrupt end, as the slowing world economy reverses the imbalance of supply and demand that drove crude to such giddying prices only a few months ago. Mining companies were also among the biggest casualties of last week’s stock-market collapse because investors expect China to cease its breakneck industrial growth. General Motors, once the world’s largest carmaker, is one of several colossal companies on the verge of bankruptcy. It has already temporarily shut down its European factories to preserve its precious cash reserves.

The knock-on effects on the rest of the manufacturing world are rippling out rapidly. Companies bought by private-equity investors are especially vulnerable because they typically rely on a ready supply of debt. In Britain, there is particular weakness in the property, construction and retail industries. Quite apart from more systemic problems in the banking industry, the loss of thousands of highly-paid financial jobs in the City will deal a devastating blow to London’s economy. Job losses will further impact consumer spending – leading to yet more job losses. Scary as it may sound, in many ways this is more familiar territory than the pure financial crisis of recent weeks. Economic recessions come and go every few years and we know that the downward spiral cannot continue forever.

This downturn may last longer than that of the early 1990s, but anyone who remembers the horrors of the 1970s knows we are still a long way from three-day weeks and the lights going out. The real mystery is how the negative feedback loop in the financial markets became so devastating. How could this domino effect happen so quickly? How could we lose control of something we designed to serve us? One answer is that this is what happens when we allow debt to get out of hand. This is not a natural disaster, but a man-made calamity caused by excessive leverage. To see the multiplying effects of leverage in action, just look at the behaviour of our big banks in recent days. The reason they have stopped lending cash to each other is not just because they fear for the survival of others, but because they desperately need whatever cash they have to meet mounting obligations of their own.

Last month’s collapse of Lehman Brothers, for example, caused a delayed stampede for cash on Friday because the banks who had offered insurance against a Lehman bankruptcy were forced to pay out. Similarly, the big banks are facing huge calls from some of their big business customers. These customers long ago arranged emergency overdraft facilities in case other means of finance became temporarily unavailable. Suddenly, everyone wants money out of the banks at the same time. All the while, the banks’ ability to raise fresh money is being crippled by the fall in the value of their own share prices. Watching these pillars of the financial community lose 25 per cent or more in value during a single day is a huge deterrent to anyone thinking of putting money on deposit , let alone invest directly in new bank shares. For this reason, even the Government rescue plan is looking more problematic by the day.

The plan, outlined by Gordon Brown and Alistair Darling on Tuesday, envisaged banks first turning to their own shareholders for more funds, and then asking the taxpayer to top up any shortfall. Yet the subsequent fall in the share prices of Royal Bank of Scotland and HBOS has made the numbers harder to square. Ultimately, if the sum of money injected by the Government exceeds the market value of the bank, it becomes hard to describe the process as anything other than nationalisation. So far, the Government has avoided using the 'n’ word at all costs – not least as it tries to encourage other governments to inject money directly into their banks, too.

Prime Minister Brown has drawn a clear distinction between what happened to Northern Rock and Bradford & Bingley – which were taken fully into public ownership – and what he expects to see at HBOS, RBS and others – which will be more akin to a temporary investment. But the vexed question this weekend is why the price of shares in these companies has continued to tumble since the Government announcement. Surely if investors believed the public stood four-square behind them, they would stop panicking? Unfortunately, they haven’t. Worse still, investors may well be behaving perfectly rationally in continuing to dump bank shares. Given the colossal demands on bank cash both now and for the foreseeable future, and given the growing gap between these demands and the cash available, it is quite possible that several of our biggest banks are literally worthless. In this case, nationalisation becomes the only alternative.

The implications for the future of the banking industry hardly bear thinking about. Running two big mortgage lenders (Northern Rock and B&B) is quite enough for the Treasury already, but being placed in charge of a major clearing bank like RBS could require the type of Whitehall intervention in the economy not seen for a generation. The politics of it all are not pretty, either. Taxpayers might be able to afford it (just) but they are not going to like it. Bonuses are also set to become a toxic political issue just as they proved a toxic financial issue. It is easy to say that the bankers directly involved should lose their bonuses – or their jobs – but what about others who have made money, or the sought-after professionals necessary to pick up the pieces?

Wall Street legal fees for handling the Lehman bankruptcy are estimated to cost more than $900?million (£530m) – with some lawyers charging $950 an hour each. How will that go down in Britain when compared with typical public-sector salaries? Meanwhile, those who work in the City can only look on with horror. Some remain frantically busy. An unlucky few have already been made redundant. Most are simply staring, like the rest of us, in slack-jawed horror at the screens in front of them. Until this passes, all normal rules of business, such as seeking to maximise the return on investment, are suspended. “It’s not the return on our money we’re worried about any more,” said one banker last week. “It’s the return of our money.”

Sovereign Bancorp Inc., the largest remaining U.S. savings and loan after the collapse of Washington Mutual Inc., may get a bid from Spain's Banco Santander SA to buy all the shares it doesn't already own.

Santander, Spain's biggest lender, is considering a bid near Oct. 10's closing price of $3.81, according to The New York Times and the Wall Street Journal, citing people familiar with the matter. The stock dropped 67 percent this year, leaving Sovereign with a market value of $2.5 billion. Ed Shultz, a spokesman for Philadelphia-based Sovereign, declined to comment on the reports.

Santander spent $2.9 billion in 2005 and 2006 to buy about 24.9 percent of Sovereign for an average $24.83 a share. The mortgage market's collapse has saddled the world's financial companies with at least $635 billion in losses, and Moody's Investors Service downgraded Sovereign earlier this month on concern that the lender will book "sizable charges" tied to its own holdings.

Sovereign operates mostly in the U.S. with 750 community offices and about 12,000 employees, according to a Sept. 30 statement. At the time, Sovereign said it was well-capitalized and "fundamentally sound by all financial and operational measures." The company became the largest public savings and loan or "thrift" in the U.S. last month when Seattle-based Washington Mutual collapsed and was absorbed by JPMorgan Chase & Co. Fifteen U.S. banks failed this year -- the most since 1993 -- including one each in Illinois and Michigan shut by regulators on Oct. 10.

Buying the rest of Sovereign would be in line with goals outlined by Santander Chief Financial Officer Jose Antonio Alvarez, who told a London conference this month that his company can "add value by rescuing failing banks at attractive prices."

Santander agreed to buy Alliance & Leicester Plc and deposits and branches of Bradford & Bingley Plc this year to make it the U.K.'s third-largest lender by deposits. Chairman Emilio Botin has made more than $60 billion of acquisitions, helping Santander become Europe's second-biggest bank by market value.

The United Arab Emirates guaranteed all deposits with local banks, including the country's two- largest lenders Emirates NBD and National Bank of Abu Dhabi, to ensure that credit continues to flow. The measure, which also includes a guarantee of all inter- bank lending in the U.A.E., is designed to "ensure continuity of economic growth and protect the national economy," state- owned Emirates News Agency reported, citing Prime Minister Sheikh Mohammed bin Rashid Al-Maktoum.

Twenty four local and 28 foreign banks operate in the U.A.E., where record oil revenue has spurred an economic boom. The seizure of global credit markets in the past few weeks has crimped lending in the local interbank market as well, prompting the U.A.E. central bank to set up a 50 billion dirham ($13.6 billion) fund to boost liquidity last month.

"This won't be enough to stop the flight of capital to larger banks," Giyas Gokkent, head of research at the National Bank of Abu Dhabi PJSC, the U.A.E.'s second-biggest bank, said in a telephone interview from Abu Dhabi today. "It is useful, but not sufficient to get banks lending again." U.A.E. nationals own 75 percent of all bank deposits and foreign borrowings only funded 9.9 percent of banks' assets, ensuring their "strong financial position," the U.A.E. central bank said in separate statement today.

Reflecting the tight liquidity, the one-month interbank offered rate, the price banks charge each other for loans in the U.A.E., climbed to 4.6 percent Oct. 9 from 3.2 percent a month ago, Bloomberg data shows. U.A.E. banks have largely sidestepped the credit crisis as most banks used their resources to fund local growth. "The majority of assets of national and foreign banks operating the U.A.E. and their parties are known and sound," the country's central bank Governor Sultan Bin Nasser al-Suwaidi said today. About 77 percent of U.A.E. bank loans are backed by assets.

Arabs own 8 percent of the bank deposits while other nationals own 17 percent, the central bank said today. Lending by U.A.E. banks surged 49 percent in the year to June. U.A.E. banks "don't have bad loans," Gokkent said. "The problem here is that the private sector has been growing faster than deposit growth and the gap has been met from external funds." Bank deposits grew 16 percent from December to June to 837.7 billion dirhams, while loans grew 23.8 percent to 893.9 billion dirhams, U.A.E. central bank data shows.

Commodities traders are rushing their private bilateral contracts into exchanges and clearing houses as they race to reduce their counterparty risk amid a deepening financial crisis. The transfer of the opaque over-the-counter deals comes as observers warn that commodities, where trading has ballooned in the past five years, could be the next market hit by counterparty failures.

Martin Abbott, chief executive at the London Metal Exchange, said the crisis was bringing new business into the LME as traders tried to reduce their risk, with turnover 45 per cent higher in September compared with the same month of 2007. “Business that was already sitting in the OTC market is now been brought into the exchange,” he told the Financial Times in an interview.

The LME, the world’s largest base metals exchange, has extended its forward-dated futures in copper and aluminium to 10 years from five as it tries to capture OTC business. Mr Abbott said: “When you look at [today’s] markets, it is utterly sensible to assume that being on exchange, with clearing house...must be attractive.”

The LME’s move comes as other exchanges are pushing into the OTC clearing business, in part to capitalise on the strong backing that regulators have given to the creation of a central clearing counterparty model for the credit derivative markets. The aim is to reduce the systemic risks inherent when credit derivatives are negotiated bilaterally between traders by having a clearing house guarantee against default.

Regulators’ focus is on the $58,000bn credit default swaps market. The commodities OTC market is estimated at $9,000bn, according to the Bank of International Settlements. Counterparty risk and tumbling prices will be key topics at the LME Week, a gathering of the mining and metals industry, which starts today in London.

Britain could face a shortage of medicines this winter as the value of sterling slides and after the introduction of a new pricing regime was botched, pharmaceutical industry chiefs said last night. Stocks of prescription drugs have fallen to their lowest level in decades, Martin Sawer, chairman of the British Association of Pharmaceutical Wholesalers, said. The Department of Health has held talks with the NHS and the pharmaceutical industry in an effort to resolve the situation.

The steep recent fall of the pound against the euro has encouraged so-called “parallel traders” to buy prescription medicines in bulk in Britain at lower cost for export to Scandinavia and Germany, to be resold at a higher price. This has been taking its toll on supplies in the UK. At the same time, the switch to a new drug-pricing regime, in which the NHS will pay roughly 5 per cent less for medicines in January than now, is forcing drug wholesalers to run down their stocks before Christmas.

They are trying to avoid a situation in which they have bought medicines at the old, higher price in December for sale at a lower price in January. Ian Brownlee, managing director of Mawdsleys, one of Britain's biggest bulk distributors of medicines, said: “It is a very substantial financial situation for us. Wholesaling is a very low-margin business so, without destocking, that 5 per cent price cut would knock our annual profits by 50 per cent.”

Mr Brownlee said that the situation had been compounded because demand for medicines was higher in January than at any other time of year. He said that in a normal year wholesalers held higher stocks at Christmas than at any other time in order to cope with high seasonal demand and requests for double prescriptions as patients prepare for the holiday period, during which many pharmacies are closed and people visit friends and relatives.Mr Sawer said that January 1 was the “worst possible date in the year” to introduce the new drug-pricing arrangements. “It should have been introduced in August,” he said.

Wholesalers are unable to reveal which drugs are most at risk because manufacturers have not said where they will make cuts under the revised price scheme. The Department of Health said that negotiations with the industry were continuing but declined further comment. The Association of the British Pharmaceutical Industry said that it took the threat of shortages seriously and was doing all it could to prevent supply problems.

Although it is frowned upon by the big pharmaceutical companies, parallel trade in medicines is a legal practice. Traders buy pharmaceuticals in bulk in one European Union country where the price is low and repackage them for resale at a profit in another country where they are more expensive. Until this year, Britain has been seen as a destination for parallel traders to import drugs sourced cheaply from Greece or Portugal, but the weak pound has virtually halted the trade into the country and instead it is being used increasingly as a place to source cheap medicines for export overseas. Because pharmaceutical companies carefully control the supply of medicines in individual countries, this has had a significant impact on supplies of particular products, Mr Sawer said.

— The NHS pharmaceuticals bill is about £11 billion a year — the new pricing regime will cut that by £550 million— Drug wholesalers are reducing their stock before the new pricing regime comes in, prompting fears of a shortfall of drugs in January, the month with highest demand— The medicine bill accounts for about 18 per cent of the total NHS budge

The world order is changing, because China is propping up the US. So the Group of Seven leaders have vowed to "take all necessary steps" to stop the world's financial immolation. That's good news. But first they are doing whatever is necessary to secure for themselves what is left of their toasted assets.

Last week Gordon Brown's priority was to use money laundering and terrorism laws to seize the British vaults of a bankrupt Icelandic bank. He says he will seize more Icelandic assets "wherever is necessary" to secure £20 billion ($52 billion) invested by Britons and British local governments.

International insolvency practitioners call it ring fencing - where rich countries, usually the United States, can lock down their borders to seize assets and jump in front of equally entitled but less muscular international creditors. That is why the US will get the lion's share of the leftovers of bankrupt investment banks like Lehmans.

But Iceland and Lehmans are sideshows in the new world of international financial cooperation and brinkmanship. The match-up that matters is between the mother of all debtors, the United States Government, and its primary financier, the Chinese Government. By now China has accumulated more than $US2 trillion ($3 trillion) in foreign exchange reserves. The holdings are not transparent. Australian officials, for example, have no idea how much Australian currency is held by China's State Administration of Foreign Exchange.

But experts in both China and the US estimate that 70 per cent of China's foreign assets are held in the form of loans to the US Government and its agencies. That means America's official debt to the Chinese Government is worth 10 per cent of America's GDP, 40 per cent of China's GDP and more than twice as much as the combined value of all of the companies on the Australian Stock Exchange.

To understand both the raw power and vulnerability of China's international balance sheet you only need to look carefully at the demise and partial rescue of the US government agencies Freddie Mac and Fannie Mae. Freddie and Fannie own or guarantee almost half of all American mortgages. To pay for these toxic loans that fuelled the US housing bubble they issued $US5 trillion in "agency" bonds.

In recent years it has been foreign governments that have footed the bill, accumulating about $US1 trillion of Fannie and Freddie agency bonds, according to Brad Setser, the sovereign wealth guru at the Council on Foreign Relations in New York. He estimates China alone holds between $US500 billion and $US600 billion.

Foreign governments, especially China, became even more important in funding bad US mortgages after the private sector financial system began to seize up a year ago. But by July even they had taken fright. US Treasury data shows foreigners - read foreign central banks - bought $US34.3 billion of US Treasury bonds in the month but sold $US57.7 billion of agency bonds. China was selling Freddie and Fannie bonds (as well as US corporate bonds and US equities) and only buying US Treasury bonds because they were explicitly guaranteed by the US Government.

By August the US Treasury Secretary, Henry Paulson, began to realise that the biggest players in the American mortgage market were unviable. The foreign governments that had been funding them were turning off the tap. The Washington Post reported that officials of the People's Bank of China told the US Treasury they expected it to "do whatever is necessary" to protect China's investments in Freddie and Fannie. The US Treasury promptly gave guarantees to China and the agency bond holders that had lent to Freddie and Fannie, while allowing shareholders to lose everything.

Last month China again tested its new-found financial leverage. The Chinese Vice-Premier Wang Qishan reportedly sought an assurance from Paulson that Chinese investors would no longer face political opposition when investing in US companies. Paulson would have gladly given that assurance if he had the political credibility to do so.

For 60 years the US has shaped the global financial system and occasionally made threats to get what it wants. In August a new era began. Now China stands between the US and national bankruptcy. Like a creditor that has invested all its savings in a single stricken business, China cannot extricate itself without seriously harming itself. Its challenge is to extract the advantages it can while keeping the US national enterprise alive.

The prospect of losing $US400 billion, perhaps even as much as $US600 billion in Freddie and Fannie was a severe shock to the Chinese political and financial system. A former senior adviser to the Chinese central bank puts it this way: "If these two companies went bankrupt, then all mortgage bonds will go down. So we will lose $US400 billion in one go." The former adviser believes China has a long fight ahead of it to save its assets.

"The bonds have been taken over by the Government so they are temporarily safe. Temporarily. China's assets are still in danger at least of devaluation, even default, so China should join other countries on how to stabilise this situation." The risk is that governments can miscalculate, they can misread each other and they can be pushed off course by domestic politics, even in an authoritarian country like China.

The overriding comfort for the world is that it makes no sense for China to abandon its US government investments. Even a hint that it might do so would send investors rushing for the door, causing the US dollar to tumble, US long-term rates to shoot through the roof and the value of China's foreign reserves to evaporate.

European leaders agreed to guarantee new bank debt and use taxpayer money to keep distressed lenders afloat, trying to stop the worst rout in Europe's stock markets in two decades and stave off a recession. At a summit chaired by French President Nicolas Sarkozy, leaders of the 15 countries using the euro hammered out an unprecedented battle plan for bandaging the crippled credit markets and halting panic among investors.

"We need concrete measures, we need unity, which is what we achieved," Sarkozy told a press conference late yesterday at the Elysee Palace in Paris. "None of our countries acting alone could end this crisis." As they improvised a response to the banking calamity that started on Wall Street, toppling Lehman Brothers Holdings Inc., Europe's leaders sought to go beyond pledges made by the Group of Seven and deflect criticism that they were making scattershot country-by-country efforts without a credible joint strategy.

"The steps taken in Europe are very positive," billionaire investor George Soros said in Washington yesterday. "The European governments have got religion and realized this is a serious problem they have to address." The key measures announced were: a pledge to guarantee until the end of 2009 bank debt issues with maturities up to five years; permission for governments to buy bank stakes; and a commitment to recapitalize what the statement called "systemically" critical banks in distress.

European banks have written down $226.8 billion out of a worldwide total of $635 billion since the U.S. subprime mortgage collapse last year set off the market crisis, according to data compiled by Bloomberg. Yesterday's agreement helped stem a decline in the euro that sent the currency to an 18-month low against the dollar.

"They pushed the boat out as far as they could," said Stefan Bielmeier, an economist at Deutsche Bank AG in Frankfurt. "It should start bringing down market rates over the course of the week. If that package doesn't help, things could really go pear-shaped for the euro area." The statement gave no indication of how much governments were willing to spend or the size of bank assets deemed at risk, leaving unclear the ultimate cost to the taxpayer. Those numbers will start to emerge today, when France, Germany, Italy and other countries announce national measures.

Yesterday was "the hour of Europe, demonstrating its unity," Sarkozy said. Today "each country will draw the consequences of what Europe decided." More than $25 trillion has been erased from global equities in 2008. European benchmark stock indexes tumbled 22 percent last week, the steepest slide in two decades. The Dow Jones Industrial Average notched its worst week since 1914. The MSCI World Index of stocks in 23 developed countries slid 20 percent, the most since records began in 1970.

After the markets dove, finance officials from the G-7 --the U.S., Japan, Canada, with Europe represented by Britain, France, Germany and Italy -- meeting on Oct. 10 in Washington signaled a determination to intervene without taking concrete steps. The euro-15 summit was the second hosted by Sarkozy in eight days, a sign of the speed at which the credit crunch has paralyzed Europe, shaking the foundations of the banking system and threatening to plunge the euro region into its first recession since the currency was created in 1999.

Anglo-Irish Bank Corp. Plc, Ireland's third-biggest lender, and ING Groep NV, the largest Dutch financial-services provider, plunged more than 42 percent last week, leading declines in banks and insurers. "We don't expect an immediate miraculous result," European Commission President Jose Manuel Barroso said. Often criticized for a preoccupation with inflation, the European Central Bank abruptly reversed course last week, cutting interest rates for the first time since 2003 in a move coordinated with the U.S. Federal Reserve and four other central banks.

The ECB doesn't have the legal power at the moment to follow the Federal Reserve and buy commercial paper to unblock a financing tool that drives everyday commerce for many businesses, said President Jean-Claude Trichet, a participant in yesterday's Paris meeting. "We are looking at our entire system of guarantees and we can imagine new measures to enlarge access to our system of guarantees," Trichet said.

Europe's divisions were laid bare by Sarkozy's initial decision to restrict the crisis-management summit to leaders of countries using the euro, leaving out Prime Minister Gordon Brown of Britain, home to Europe's largest financial market.Brown, sensing an opportunity to reverse plunging poll ratings by showing leadership in a crisis, last week set up a 50 billion-pound ($85 billion) program to invest in at least eight British lenders and pressed euro-region leaders to concoct similar plans.

A late addition to the guest list, Brown spoke at the start of the session before hastening back to London to work on new steps to stop the financial rot in the U.K., possibly to be announced before the markets open today. "European leaders have come together in the recognition that although they can do things individually they are far better achieving something that is bigger by working together," Brown said.

Brown's government will today take controlling stakes in Royal Bank of Scotland Group Plc and HBOS Plc, two people familiar with the plan said. The government will name representatives to the boards of both banks and work with the management on issues including executive pay, said the people, who spoke on condition of anonymity because the information is confidential.

Portugal yesterday announced that it will make as much as 20 billion euros ($27 billion) available in guarantees for the financing operations of its banks. Norway, not a European Union member, offered banks as much as $55.4 billion in government bonds in exchange for mortgage debt. In the U.S., Treasury Secretary Henry Paulson will tap some of the $700 billion financial-rescue package approved by Congress this month to buy equity in financial companies.

At Sarkozy's first crisis-response meeting, on Oct. 4 in Paris, leaders of France, Germany, Britain, Italy, Luxembourg, the ECB and European Commission stopped short of setting up a regional bailout fund. There were signs that German Chancellor Angela Merkel, an initial opponent of French calls for a joint bank-rescue fund, was rethinking her stance.

A German program may allot up to 100 billion euros to recapitalize private banks, state banks and insurers, Handelsblatt reported over the weekend, citing unidentified officials. Merkel said the plan would involve "providing banks with sufficient capital so that they are able to operate on their own -- and I don't rule out that there could be capital support."

More than five years ago, in April 2003, the attorneys general of two small states traveled to Washington with a stern warning for the nation's top bank regulator. Sitting in the spacious Office of the Comptroller of the Currency, with its panoramic view of the capital, the AGs from North Carolina and Iowa said lenders were pushing increasingly risky mortgages. Their host, John D. Hawke Jr., expressed skepticism.

Roy Cooper of North Carolina and Tom Miller of Iowa headed a committee of state officials concerned about new forms of "predatory" lending. They urged Hawke to give states more latitude to limit exorbitant interest rates and fine-print fees. "People out there are struggling with oppressive loans," Cooper recalls saying. Hawke, a veteran banking industry lawyer appointed to head the OCC by President Bill Clinton in 1998, wouldn't budge. He said he would reinforce federal policies that hindered states from reining in lenders.

The AGs left the tense hour-long meeting realizing that Washington had become a foe in the nascent fight against reckless real estate finance. The OCC "took 50 sheriffs off the job during the time the mortgage lending industry was becoming the Wild West," Cooper says. This was but one of many instances of state posses sounding early alarms about the irresponsible lending at the heart of the current financial crisis. Federal officials brushed aside their concerns. The OCC and its sister agency, the Office of Thrift Supervision (OTS), instead sided with lenders.

The beneficiaries ranged from now-defunct subprime factories, such as First Franklin Financial, to a savings and loan owned by Lehman Brothers, the collapsed investment bank. Some states, including North Carolina and Georgia, passed laws aimed at deterring rash loans only to have federal authorities undercut them. In Iowa and other states, mortgage mills arranged to be acquired by nationally regulated banks and in the process fended off more-assertive state supervision. In Ohio the story took a different twist: State lawmakers acting at the behest of lenders squelched an attempt by the Cleveland City Council to slow the subprime frenzy.

A number of factors contributed to the mortgage disaster and credit crunch. Interest rate cuts and unprecedented foreign capital infusions fueled thoughtless lending on Main Street and arrogant gambling on Wall Street. The trading of esoteric derivatives amplified risks it was supposed to mute. One cause, though, has been largely overlooked: the stifling of prescient state enforcers and legislators who tried to contain the greed and foolishness. They were thwarted in many cases by Washington officials hostile to regulation and a financial industry adept at exploiting this ideology.

The Bush Administration and many banks clung to what is known as "preemption." It is a legal doctrine that can be invoked in court and at the rulemaking table to assert that, when federal and state authority over business conflict, the feds prevail -- even if it means little or no regulation. "There is no question that preemption was a significant contributor to the subprime meltdown," says Kathleen E. Keest, a former assistant attorney general in Iowa who now works for the Center for Responsible Lending, a nonprofit in Durham, N.C. "It pushed aside state laws and state law enforcement that would have sent the message that there were still standards in place, and it was a big part of the message to the industry that it could regulate itself without rules."

"That's bull----," says Hawke, the former comptroller. He returned to private law practice in late 2004 with the prominent Washington firm Arnold & Porter. Once again representing lenders as clients, he confirms the substance and tone of the April 2003 meeting with the state AGs, saying they "simply had a fundamental disagreement." But he denies that federal preemption played a role in the subprime debacle. Hawke blames much of the mess on mortgage brokers and originators who, he says, were the responsibility of states. "I can understand why state AGs would try to offload some responsibility here," he adds. "It's important to remember when people are trying to assign blame here that the courts uniformly upheld our position."

His arguments have some merit. The federal judiciary has bolstered preemption in the name of uniform national rules, not just for banks but also for manufacturers of drugs and consumer products. And state oversight alone is no panacea, as the chaotic state-regulated insurance market illustrates. Inadequate supervision of mortgage companies in some states contributed to the subprime explosion. But the hands-off signals sent from Washington only invited complacency. When some state officials fired warning flares, the Administration doused them.

Consider a clash in 2004 between the OCC and regulators in Michigan. In January of that year attorneys working for Hawke filed a brief in federal court in Grand Rapids on behalf of Wachovia , the national bank with $800 billion in assets based in Charlotte, N.C. Michigan wanted to continue to examine a Wachovia-controlled mortgage unit in the state, which the bank had converted to a wholly owned subsidiary. The parent bank sued, claiming Michigan could no longer look at the mortgage lender's books. Citing the threat of unspecified "hostile state interests," the OCC argued in its brief that "states are not at liberty to obstruct, impair, or condition the exercise of national bank powers, including those powers exercised through an operating subsidiary."

Michigan countered that Wachovia Mortgage was not itself a national bank. The Constitution preserves state authority to protect its residents when federal statutes don't explicitly bar such regulation, Michigan contended. Ken Ross, the state's top financial regulator, says his department fought Wachovia all the way to the U.S. Supreme Court in part because it feared a growing subprime mortgage problem: "We knew there needed to be (state) regulation in place or there could be gaps." The OCC, he adds, "did not have robust regulatory provisions over these operating subsidiaries."

The nation's highest court sided with the Bush Administration, ruling in April 2007 that the OCC had exclusive authority over Wachovia Mortgage. Justice Ruth Bader Ginsburg, writing for a five-member majority, pointed to the potential burdens on mortgage lending if there were "duplicative state examination, supervision, and regulation." In a dissenting opinion, Justice John Paul Stevens said that it is "especially troubling that the court so blithely preempts Michigan laws designed to protect consumers."

By the time of the Supreme Court decision last year, Wachovia and its mortgage operations in Michigan and elsewhere were feeling the ill effects of unwise lending. As real estate prices continued to fall this year, pushing many borrowers into default, Wachovia teetered on the edge of failure. In late September the federal government stepped in to arrange a fire sale. Wachovia now may be carved up between Citigroup and Wells Fargo.

Confrontations such as Michigan's battle with Wachovia became far more common after George W. Bush took over the White House in 2001 and instituted a broad deregulatory agenda. The OCC, an arm of the Treasury Dept., has adhered closely to it. The agency oversees more than 1,700 federally chartered banks, controlling two-thirds of all U.S. commercial bank assets. Historically, its examiners have monitored bank capital levels and lending to corporations more attentively than they have the treatment of individual borrowers. "Consumer protection has always been an orphan (among federal bank regulators)," says Adam J. Levitin, a commercial law scholar at Georgetown University Law Center.

The OCC brought 495 enforcement actions against national banks from 2000 through 2006. Thirteen of those actions were consumer-related. Only one involved subprime mortgage lending. OCC spokesman Robert Garsson says the figures could be misinterpreted because the agency addresses many problems informally during bank examinations. He declined to provide any examples.

Beyond the influence of free-market theory, turf concerns have reinforced the Administration's determination to exercise responsibility for as many lenders as possible -- and prevent state incursions, notes Arthur E. Wilmarth Jr., a professor at George Washington University Law School. Almost all of the funding for the OCC and OTS comes from fees paid by nationally chartered institutions.

Hawke says the OCC seeks only to exercise powers that it has long held under federal law. It is far more efficient for national banks to deal with one set of federal rules than a hodgepodge of state directives, he argues, echoing the Supreme Court's majority view. By the late 1990s, he adds, more state legislatures and AGs were trying to bully national banks by, for example, restricting ATM fees charged to nondepositors. State officials "found it politically advantageous to assert these kinds of initiatives," he says. The OCC's heightened preemption campaign "was occasioned by the fact the states were becoming more aggressive."

The current head of the OCC, John C. Dugan, concurs. "To claim that it is our fault from preemption is just a total smokescreen to shield the fact that the state mortgage brokers and mortgage companies were just not regulated," Dugan says. Efforts in Georgia to rein in unwise lending provoked a particularly fierce federal reaction. In 2002 the state passed a law that imposed "assignee liability" on the mortgage-finance process. Understanding the significance of this requires a little background.

One of the forces that accelerated the proliferation of dangerous home loans was the Wall Street business of buying up millions of mortgages, bundling them into bonds, and selling the securities to pension funds and other investors. Securitization, which grew to a $7 trillion industry, meant the lenders could pass along the risk of default to a huge universe of investors. Many of those investors, in turn, relied uncritically on reassurances from fee-collecting investment banks and ratings agencies that mortgage-backed securities were high-quality. When many of the reassurances proved hollow, the securitization market collapsed this year.

Assignee liability would radically reshape that market by making everyone involved potentially responsible when things go bad. Investment banks that created mortgage-backed securities and investors who bought them would be liable for financial damage if mortgages turned out to be fraudulent. The financial industry opposed assignee liability, maintaining that it would cripple the market for asset-backed securities. Major ratings agencies later agreed that allowing unlimited damages would be disruptive. The agencies threatened to stop evaluating many bonds tied to mortgages covered by the Georgia law.

But some banking experts speculate that if Georgia's example had spurred more states to adopt broad assignee liability, greater caution would have prevailed in the mortgage-securities market, possibly preventing the blowups of Lehman, Bear Stearns, and other once-mighty institutions. "If the Georgia law had held, it is possible that other states would have followed and there might have been change earlier," says Ellen Seidman, who headed the OTS from 1997 through 2001.

Roy Barnes, Georgia's governor in 2002, understood the potential significance of assignee liability when he signed the state's new Fair Lending Act that year. He recalls a breakfast meeting with banking lobbyists during which he admonished the industry to clean up reckless lending. He jokingly threatened to hire "the longest-haired, sandal-wearing bank commissioner you ever saw." But the bankers fought back, seeking to undermine the new law. The OCC's Hawke assisted the industry by issuing a ruling in July 2003 saying the Georgia law did not apply to national banks or their subsidiaries. A fact sheet prepared at the time -- and still available on the OCC's Web site -- says: "There is no evidence of predatory lending by national banks or their operating subsidiaries, in Georgia or elsewhere."

The OCC ruling had been requested by Cleveland-based National City Bank on behalf of several of its units, including First Franklin Financial, a subprime lender that operated in Georgia and other states. First Franklin, which was acquired by Merrill Lynch in 2006, has been hit with dozens of suits alleging unfair lending practices. Merrill shut down First Franklin's troubled lending business in March. Itself hobbled by mortgage-securities losses, Merrill agreed last month to be acquired by Bank of America. The bank and Merrill declined to comment.

In August 2004, Hawke went a step further in a letter to the Georgia Banking Dept. He said even state-chartered mortgage brokers and lenders were exempt from the Georgia law -- if the loans they handled were funded at closing by a national bank or its subsidiary. By then support for the Georgia law was already eroding. Barnes, a Democrat, lost his reelection campaign in November 2002, and his Republican successor moved to dilute the lending act. Still, supporters mobilized to defend the legislation. One was William J. Brennan Jr., an Atlanta legal aid attorney who specializes in housing and had testified before the U.S. Congress in 2000 about what he saw as the looming mortgage mess.

He told the House Financial Services Committee: "The entry of many prominent national banks into the subprime mortgage-lending business has resulted not in reform, but in the expansion of the abusive practices." Federal regulators, he testified, "have done little to stop" the trend. In early 2003, Brennan and a legal aid colleague, Karen E. Brown, consulted with Georgia legislators trying to block amendments softening the lending law. At a hearing in February, Brennan requested a police escort because he feared that angry mortgage brokers would block his way. "The words that come to mind are 'outgunned' and 'overwhelmed,' " says Brown.

The Georgia legislature sharply curtailed the assignee liability provision in March 2003 and eliminated other elements of the law as well. Subprime lenders such as Ameriquest Mortgage that had halted lending in Georgia in protest of the law resumed marketing high-interest, high-fee mortgages. But by late 2007, Ameriquest had gone out of business after agreeing to a $325 million settlement to resolve suits alleging that it had made fraudulent loans. Georgia now has the sixth-highest rate of foreclosure in the country. Consumer advocates and state attorneys general contend the weakening of the state's law was a severe blow to efforts to curb careless lending. "Had the Georgia Fair Lending Act not been watered down, we would be in a very different place right now," says Brown.

In some states, dubious local mortgage firms sold themselves to national banks, gaining protection against state enforcement. The Iowa Division of Banking in 2006 sought to examine a subprime broker called Okoboji Mortgage in the town of Arnolds Park. A borrower had accused the firm (named for an area lake) of duplicitous lending practices. Cheryl Riley, a 52-year-old janitor, told state officials she had not received the 30-year fixed-rate mortgage she thought she had arranged with Okoboji in 2005. Instead of one monthly statement, Riley got two: one for a 9.25% adjustable-rate loan and another for a 15-year fixed loan at 12%. Both rates were far higher than what Riley and her husband thought they had negotiated. "We were horrified," she says.

A preliminary state investigation found that Okoboji's manager had headed a mortgage firm in Nebraska that lost its license for falsifying loan documents. But Okoboji refused Iowa's demand for an examination, forcing the agency to file suit in August 2006. Okoboji responded by announcing that it had been acquired by Wells Fargo, a nationally chartered bank regulated by the OCC. Okoboji handed in its state license, saying it no longer had to comply with Iowa rules. "We'd had red flags but were now blocked from investigating," says Shauna Shields, an Iowa assistant AG.

Okoboji's former manager, Lyda Neuhaus, calls Nebraska's earlier actions "a witch hunt" based on "12 miserable complaints." Her father, Juan Alonso, who owned Okoboji, says he sold his company because he wanted to retire, not to escape state regulation. Both deny any wrongdoing. A Wells Fargo spokesman declined to comment on Iowa's concern about Okoboji and defended the acquisition as benefiting customers and shareholders.

The experience with Okoboji was the sort of thing that Iowa AG Miller had warned about when he joined his counterpart from North Carolina on their visit to OCC chief Hawke in 2003. "Now, we could not do anything with federally chartered banks or subsidiaries," Miller says. In 2006 and 2007 the Iowa legislature shot down proposals by Miller for more- restrictive lending laws. Lax regulatory standards at the federal level helped undermine his efforts, he explains. State-chartered banks insisted that tougher rules in Iowa would put them at a competitive disadvantage with federally chartered banks overseen by the OCC. "We had to acknowledge the [political] environment we were in," Miller says.

The banking industry repeated the argument for regulatory "parity" in many states that tried and failed to tighten supervision of subprime lenders, says Keest of the Center for Responsible Lending: "State institutions then wanted a level playing field, which was a playing field with no rules." Hawke says that it would have been inappropriate for the states to impose more-stringent standards on federally chartered institutions: "Had they tried to apply those rules to national banks, they clearly would have been preempted."

In Cleveland in 2002, Frank G. Jackson, then a member of the City Council, could see that many lower-income residents were being persuaded by lenders to pile on high-interest debt. "It was pure greed, based on exploitation," he says. "(Some subprime lending) is just the same as organized crime." He started negotiating with mortgage lenders for more-favorable terms. To his surprise, the lenders bypassed him and persuaded the state legislature to enact a less stringent version of an anti-predatory lending act he was drafting. "I figured the good faith had ended, so I passed my law (at the city level)," Jackson says. That law required lenders to register with the city and provided counseling to prospective borrowers.

His accomplishment was short-lived. That same year, the American Financial Services Assn. (AFSA), a national trade group, sued to block Ohio municipalities from passing lending laws that conflicted with state statutes. The Ohio Supreme Court later sided with the industry. AFSA's goal was to ward off conflicts between federal, state, and local rules, says spokesman Bill Himpler. "Different municipalities moving different anti-predatory lending legislation . . . would have brought the credit markets to a screeching halt." Fulfilling Jackson's fears, the Cleveland area has become one of the places worst hit by the mortgage catastrophe. More than 80,000 homes have gone into foreclosure since 2000, the highest per capita rate in the country.

In January, Jackson, elected the city's mayor in 2005, tried a new tactic. He filed suit in state court against Lehman, Wells Fargo, and 19 other lenders, alleging that they sold "toxic subprime mortgages . . . under circumstances that made the resulting spike in foreclosures a foreseeable and inevitable result." The city's attorneys based the suit on an Ohio law banning "public nuisances," which is usually used against defendants such as manufacturers whose factories emit pollution. The idea was to steer clear of conventional banking law and head off any claim of federal preemption. The suit is pending; the banks all deny wrongdoing.

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Anonymous
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RE: "...But even supposing that it will work for a while, what then? ..."

In this context, what does 'work' mean? Does it mean temporize the inevitable? That inevitably the worthless paper, stinking up the vaults to the tune of tens of trillions of dollars, will have to come out into the light of day. And then when it does...poof. And that ALL of these current ministrations are simply ways to delay the 100% no doubt catastrophic eventual collapse of the whole fetid thing?

Wouldn't it be nice to really know what's going on behind all these maneuvers? If the various nations taxpayers are now buying into banks every which where then presumably that dilutes current ownership tremendously. Was the market crash created intent on reducing the cost of this buy in? I've read that in recent years the world's largest sovereign wealth funds have being buying bank ownership. I would think they must be pretty pissed right now. Or maybe they are happy to only lose something and not everything. But I have to wonder if TPTB thought that maybe a little too much ownership was being held by unfavorable interests and having a grand old bank sale and massive buy in was one way to dilute that unacceptable condition. But what do I know. I'm sure I'm missing a lot. Machinations are in play and one can't help wonder if results are really not what was intended. What would the retaliation be? Would oil production be curtailed until the pain matches the gain? I just wonder.

Priceless comment, Ilargi, about homeowners paying to kick themselves out of their homes! Brilliant stuff, in the mode of Johnathan Swift, Mark Twain, H.L. Mencken and Will Rogers!! Boggles the mind that the Politicians and Financial Wizards of OZ behind the curtain can opine this blather about saving us from ourselves? The need for a purging of toxic waste from corporate, banking and soon government balance sheets through normal recessionary adjustments just never seems to enter their closed minds! Can anyone see a way that this bailout can truly liberate the global shutdown except by adding to the fear and distrust of the sheeple and their savings? What a turd of a problem to leave to our kids & grandkids and whoever ascends to the presidency in 22 days.

Is this the classic comic book version? Seriously, when all the major players are shown to be insolvent - then what happens? Is this some exotic black hole or early big bang phenomenon where the current laws of physics do not apply? Do we enter a singularity or is the Kingdom of God at hand? Ilargi says that this should be done - all toxic assets be laid on the table, but no one is willing or able to describe in any meaningful and explicit detail (and "splat" is neither) - what happens next.

I don't know what happens. I believe that we are going to witness a global paradigm shift of never-before-seen proportions. Economies laid bare and failing, new nation-states born, civil unrest, an age of warlordism in a most post-modern sense...

But I am having difficulty merging my present, father-of-two, undramatic, one-day-at-a-time existence with a growing understanding that the world has destroyed it's delicate fabric of social organization and is destined in the all-too-near future to have to reinvent and struggle to create a new one.

also...

Totally amazing is all I can say....We are a species destined to destroy ourselves because (a) we have lots of knowledge about how to build things like nuclear weapons and (b) we are apparently instinctively aggressive and greedy.

Look at the markets and all of the prattle today. DOW up 700 points...lots of folks hoping to make money...the richer I am the better...money money money money.

And of course it is the quest for wealth and power that is destroying us: Me and my Lamborghini whilst millions of bloated babies starve in Ethiopia...hey man, tough luck for them...glad I was born here and not there.

And we're ALL guilty...ain't no one clean here...it stinks, and we've all got shit on our shoes to some extent. How many of us wouldn't trade places in a New York second with Buffet or Mark Cuban or Gates or any number of the filthy rich.

And so the beat goes on...the market "rallies" and it's time to make some coin while the makin' is good.

Ya, our politicians are scoundrels and thieves...and more importantly, just plain old idiots. But they're no different from us. 99% of us would play right along with the game for our $165,000 salary and our cool exciting lifestyle in D.C. and rubbing elbows with the world's elite...whoring ourselves for ourselves and in spite of ourselves.

Pathetic lot, we humans.

Well, I'm glad the DOW is rising...today. I hope the LIBOR comes in and banks stretch their armss after this brief slumber and all is right as rain...and the of the toxis swaps out there somehow magically disappear and normalcy reigns once again...and all of us, the angry few, the pseudo lumpen proletariat, say "to hell with this blog and with humanity", and we jump back into the market with both feet and hope to hell we can line our pockets too.

So Fascinating. What is that old metaphor about the dog and his vomit? Or the one about Lemmings??

I agree with those on this blog and others---with Ilargi and Stoneleigh---who so rightly point out that there is NO WAY to obfuscate ad infinitum: that eventually EVENTUALLY the toxicity will no longer be able to be hidden from view...and at that moment the entire financial system that we have constructed (thrown together?) will dissolve.

But meanwhile, while there is still a pretend system that is able to make people some more cash, EVERYONE plays along.

It's so weird. It's like we've discovered a really big rock hurdling through space at Earth, and it's definitely coming, and it'll be here in 2 years, and our daughter is 9 years old and we continue to put 15% of our money into her college fund. Weird.

" and we jump back into the market with both feet and hope to hell we can line our pockets too. "

Well, let's not be too hard on ourselves trying to plan ahead and ease the burden of the coming Great Tribulation. I&S have gone to much effort here to allow those who wish to hear to prepare. (Sounds like an OJ trial - ¡if the ear do hear then you must prepare!) And while most of the preparation involves getting close to the earth and your community, some of it involves trying to minimize your debt (which will be more onerous) and hold onto some assets (which may be as difficult as shooting a springtime Rocky Mountain stream in a kayak). If we treat our neighbors and the earth decently, there is no sin in trying to prepare for future survival. Sinking into the Slough of Despond does no one any good.

As to putting 15% of your income into your daughters' college fund - just keep the fund in Treasury Direct in 13 week T-Bills. When your daughter turns 18 there probably won't be any colleges, but it might buy a lot of agricultural implements.

I worry the US Gov will default. In 10 days I was up 48% shorting the S&P, down 25% today. A wee bit bumpy! One of the three Dow Theory sites says the advance is back on --course they can't predict for how long...

OK here is my possibly flawed picture of what happened when some brave country finally decides to drag all the trash into the light and let actual market values rule. Some country is going to do it eventually. It probably won't be a big or powerful one that does it first.

When this country finally decides to actually apply transparency, all of the big players in that country will be shown to be insolvent. And most of the medium ones. And many of the small ones. But not everyone. A few medium players and some of the small players will still be solvent. There will be businesses in this country, whichever country it is, that are moral equivalents of the little bank over in Morton, Ill, by us that never moved away from 20% down payments and actually verifying the claims that potential customers made to them.

This country will swallow hard, and all the big powerful players will enter bankruptcy protection of one form or another, despite their lobbyists and ties to the government, and many will vow revenge on the civil servants who opened the vaults. The few little and medium survivors will scale up as quickly as they can. There will be much jockeying over who gets to recover how much from the broke institutions. The velocity of money will slow to a crawl, the rest of the world will look in horror at the first country, and say that its prices don't really count as a market, but only as firesale prices.

But this first country will reach its bottom, healing will begin. It will slowly pass its solvency crisis, and will be back to liquidity crisis, only its liquidity will not really be a crisis so much as the new (low) levels of normal. And as things slowly normalize liquidity will slowly come back. This country will not enter the kind of recoveries we've seen in the past, because it will probably have diminished access to oil, and as it is adapting to lower wealth, and lower liquidity it will be adapting to lower energy too. And the rest of the world will be in turmoil. Nonetheless this will be the beginning of a healing process, in the sense of transforming from crisis to the "new normal" and most of the players in this countries new normal will be previous bit players, rather than previous biggies. But, well the small players trying to scale up will hire some of the people from the old big players. And the government will solemnly vow never to let this happen again, and create a whole slew of regulatory mechanism (while retiring old ones). Then global banking will work on subverting a new generation of businesses and regulatory agencies and the grand cycle will begin again, at a less energy intense level. As this first country normalizes, more and more desperate countries will decide to take the medicine of transparency to restore trust, often after serious political battles from the old regime.

The craftiest of the biggies will play a shell game moving their real assets out of a country before the light is shown, but dumping their trash into vaults that are about to be opened, sacrificing some limbs, until finally they have gotten rid of enough trash and can actually look solvent in some country or other, or prevent that country from ever opening up. And then when they think everything is over, they will move back into trying to subvert the survivors.

Anyway that's my vision for what happens after some country finally goes the rout of transparency. I could be wrong and corrects are appreciated.

The Bush administration will announce a plan to rescue frozen credit markets that includes spending about half of a total of $250 billion for preferred shares of nine major banks, people briefed on the matter said.

The companies are Citigroup Inc., Wells Fargo & Co., JPMorgan Chase & Co., Bank of America Corp., Goldman Sachs Group Inc., Morgan Stanley, State Street Corp., and Bank of New York Mellon Corp., the people said. One of the people also said Merrill Lynch & Co. will receive an investment.

Understand what happens when the inevitable occurs: As I've said before, NOTHING will retain ANY value. Everything: Currencies, economies, cultures, countries -- they all will fall once this hits the table. That's why you can't have a full accounting. All social order depends on some form of this crap to continue.

anonymous: Yes. And if they don't do it, runs on all the banks and they become Iceland _anyway_. They might as well finish the job and monetize everything and send the whole world down in flames like Weimar Germany.

el_pollo: More like Armageddon for the present social order -- all over the world. As in "The End" of society, social order, economy, currency, and country.

newbie: I give it another day or two until some sobering economic news from the States starts the process again.

Blue Monday: Denninger's (whom I respect) plan won't work because the whole system is built on this toxic crap. A quadrillion dollars worth, give or take. The only thing buying your toxic crap is my toxic crap. If all of it were laid out in the open, no one would have anything to buy it out _with_, and the entire process goes splat. Even the Lehman auction was seen, largely, as a farce by Ilargi, even though Denninger said that even 10 cents on the dollar proved his plan could work because the stuff had _some value_. It doesn't -- nothing does.

You're right -- they want to put it over to Obama (especially). Problem is, how many trillion is it going to cost to do it?

el_pollo: Better to invest in the implements now. If he holds the money in T-Bills too long, the currency will have no value.

bigelow: The advance IS back on -- but understand why (and it took me a while to as well): Countries are now going to have to gamble everything they "have left" (not that they have anything, once you look at all the toxic crap) that they can prop up the banks and prevent a mass run on world banking which will end many of the countries. They're risking everything because they know they lose everything once it all goes to crap.

Brian M.: I'm interested in how you think anyone can be solvent in that scenario. I don't think it would matter anyway, but I don't think anyone would be solvent, or much less "left" at that point. If they're solvent, they'd be insolvent rather quickly after the entire mechanism required to keep them in business fails. But I am curious, if you could tell me, how even some of the medium/small players could be solvent in your scenario...

Welcome newbie!Regretably I can't recall who posted this idea recently but the suggestion was that the daily TAE postings since day one on this financial crisis are the best available/written diary of events to be found. I think future historians will reference its exceptionally clarity. Canada votes in a general election to-morrow. I feel like I need to stay awake,stand vigil ,that something bad will happen if I fall asleep. I want the Green Party to elect a sitting Member of Parliament!

The only way even small banks that used old fashion standards would come out solvent is if they were in a 'micro economic climate' where by the local economy still provided paying jobs so their local mortgages could still be payed each month.

I don't know of any self contained areas in the US that exist this way.

They are all tied into the larger banking picture.

The only communities I can think that would come out of this even vaguely OK are ones with no loans.

Well, I may be a bit shell-shocked by recent events, but it seems to me more probable as each day (hour?) goes by that the deflationary prelude to hyper-inflation may be much shorter than anyone would have thought possible.

ilargi: There is no limit now. They've been doing this anyway (what do you think started the two 800-point leaps Friday -- PPT buys the financial stocks to prop them up!!) Fact is, they have two options: Mass social unrest in a run on the banks, or basically nationalize the banks.

anonymous 2223: It's all over. Said it weeks ago and people told me to chill the F out. Sorry. I don't have much longer here. No one does without a lot of guns and a lot of stocked-up food.

Look I know individual people who are solvent. They own assets free and clear and are debt free. They have incomes. If their incomes disappear, they still have real tangible assets. If all banks and businesses in a whole country are insolvent, maybe the transparent country will have to go all the way to solvent individuals loaning things. That's a massive decline in liquidity, but I'm not even sure what it could mean for everyone to be insolvent. Heck, banks began from goldsmiths.

And I genuinely don't think every business is insolvent in any country. Again maybe Indiana is non-indicative, but there are little restraunts and local shops that own their premises free and clear, that sell and order, and may have bills floating at any point but also have lots of tangible assets. That little bank a town over, owns mostly local real estate which didn't run up much during the bubble, and it is probably going down and will go down more, but it won't vanish in value like real estate in Nevada. And I'll bet that bank has few liabilities and little leverage. If I'm wrong, there will be some other little conservative local bank somewhere.

Look money is created by debt, and there is never enough money in the system to pay all debts and all interest, so the system as a whole is always on average insolvent, and relies on continual growth. But things are distibuted more chaotically than that, some have nowhere near enough assets to pay their debts and hide it and bet double or nothing as long as they can. Some are close, but never quite get clear. Some have more than enough to pay their debts and are solvent. I would expect that basic distribution in pretty much any society with a money as debt system. Every business who is nowhere near solvent, means somewhere in the system is that difference, unless it has been snuck out to the next country over. And in most countries there are plenty of nowhere near solvent folk. So no matter how bad it gets I just can't believe that every player big and small can be insolvent in any country. At the very least, there will be a hermit somewhere with no debts and almost no assets, but who owns something of value.

1) We're going to go through a VERY violent upheaval in this country. There's no getting around this. You can call it "race war", "class war", "civil war", "just trying to get by", or whatever you want to call it. There's going to be a timeframe where even those "solvent", as you propose, are going to need to defend that "solvency". As I've said before, at least for a time, we will go from ownership through resources to ownership through guns.

2) From there, say we get through all that. What allows that system to work if there is no overlaying sense of value anymore? What if we truly devolve (so to speak) 150 years and go back with no real power grid, no real national sense of government, nor much else which has sustained us (again, so to speak) as a society for the last 40 years or more?

What I'm saying is that it might not matter that an individual is solvent if he can neither defend his property against what is almost certainly going to be mass civil unrest, nor can he defend it against the fact that nothing he really has or does is really worth anything anymore -- because there is no standing value to anything, nor a real means to gain it.

All the local small town business that are solvent and own their premises and equipment free and clear need to order supplies from outside their area.

Paper goods, hardware, food, fabric, you name it.

That 'Just in Time' distribution system that keeps small town businesses humming is very efficient but very fragile, as in not reliable because it has no redundancy or resiliency.

There is almost no warehousing of inventory locally anymore. Stores often have just one or two items on the shelf. If it gets bought, they order a second one. Auto parts run on the thinnest of inventory these days.

Payment systems for delivered goods is often as fragile as the literal distribution system is.

If Peter doesn't pay Paul, today, no goods get delivered, and the system collapses quite quickly. The process has no there there. It's timed very closely, delivery and payment in full.

Any national or large regional inventory disruptions due to wide spread bankruptcies, and not much of anything will work very long, big town or small town.

Starcade, I hear the fear in your writing. And I can empathize. When I first grappled with peak oil three and a half years ago, I went through a period of borderline diagnosable depression. I was certain the stockmarket would crash at any moment and we'd be plunged into a world of gangs and warlords overnight. I read the same hysterical tone in your posts that I felt at that time. I don't want to minimize the reality of the current crisis (or your emotional response to it) because it is real, and many people are going to lose everything (including their lives) in the coming turmoil. But the gutting of the middle class does not mean that every supply chain is going to break in one fell swoop and that by Christmas of this year we will need to knap old cathode ray tubes into arrow heads to defend ourselves from the more heavily armed. IF it gets that bad that fast probably more than 90% of us, even those of us who read this blog, will be toast. I'm not prepared for that scenario and I've been aware of the need to prepare for years.

I invite you to consider that there are other plausible courses for how things will turn out. For example - crime rates will escalating in the face of economic dislocation does not mean that if you don't have a gun somebody is going to show up and take what you have. The risk of this happening will increase, but stealing at gunpoint is a risky proposition for the theif too, and eventually they'll try to steal from the wrong group... with obvious fallout.

As Stoneleigh has written many a time - we are entering a world of increased risk compared with the last few decades. The risk:benefit calculus is changing and changing rapidly, but armed robbery is always going to be last resort.

Finally, I invite you to take the following non-pharmaceutical steps to protect your mental health that I found helpful when I was TOTALLY freaked out. 1. Drink lots of water2. Make sure you get at least an hour or two of sunlight EVERY day3. Exercise4. Take B vitamins (semi pharma, but not obtained by Rx)5. Talk to your friends (or a professional counselor) about your fears

Some fears are entirely rational and goad us to take constructive action. Living in a constant state of fear is unhealthy and hard on teh body - taking steps to reduce the impact of the ongoing stress of daily living will increase your likelihood of making it through the coming hard-times.

I've been thinking about medical care in the coming years a lot recently. Today in the ER we had a guy who fell out of tree and shattered both his feet and ankles. We shipped him off to a major surgery center to be patched up (his left ankle was compound and bled the entire time he was on the gurney in our dept). That is the kind of injury that freaks me out in teh coming years. Right now we perform surgery and pump the victim full of antibiotics. In the not too distant future it may very well turn into a "wait and see" scenario of whether an infection sets in, followed by letting the bones knit as they will. That was a dramatic example, and there are many lower-level problems too - infections around toes, abcessed teeth, cellulitis - all are pretty easily dealt with right now. The pain and suffering coming down the line for those who lose access to antibiotics because of inability to pay will suck...

If there's one thing ER work has taught me - one can never be too careful when performing dangerous activities that threaten life or limb.

Anon,I am just a collection of free electrons floating thru the net.But here is a question.

Do you trust the people who just raped this country to ensure the ability of people like you to get their funds while they still have worth?Do you trust these pirates to act in a honorable manor?Those that have wealth ...that keep wealth ..get out "too soon"as the saying goes.

Hold your money in your hand...or a sock at the bottom of a drawer..

I don't have faith in the final antics of the last "masters of the univerce".I&s gave a good hint...events will occur faster than the ability of those"in charge" to respond.We have constructed a machine that we cannot control...the world financial system was poisoned by the greed of a few...and the whole world will suffer.

I think this may be part of the reason why there was so much resistance to the usa being part of a world court...we have a lot of world class criminals that have our own justice system tied up in knots...who have virtual immunity due to their wealth.

This is not the case in some other parts of the world.If Obama wanted to clean house,all he has to do is recognize the world court...and watch the fireworks

Not a good graph for comparison but it looks like the 1000 point gain today off of the 15000 market top is a ratio of one to fifteen while the 1929 was one to eighteen with a little up lift after that and then the big slideroo. I wonder what will happen tomorrow? ---------

ilargi said:

U.S. Treasury Said to Invest in Nine Major U.S. Banks

That's about $3 trillion in 4 days.

Sheesh ilargi I wish you wouldn't start preaching in Latin just when things get interesting, would you mind continuing that in the King James version?

I have money in bonds...found your site too late before the drop. My gut tells me to take them all out, regardless of the loss. What say you (or anyone)?

It depends what kind of bonds you hold. Any kind of high yield bond is not a good idea at all, since chasing yield means chasing risk. I would suggest getting out of corporate bonds quickly, and I would move out of long term treasuries, but not as a matter of urgency. Short term treasuries and cash are the safest repositories of wealth at the moment, as you need access to liquidity while it's still obtainable. Don't trust the banking system with it though.

Getting out of debt if you have any is very important as well, as debt becomes a millstone round the neck very quickly in a deflation.

As i look at what happened in Argentina and Venzuela when the IMF hit their credit ratings, I wonder if we're looking ta the whole picture here.

Didn't both nations go hyper-inflationary during their credit collapses? and by hyper-inflationary, didn't the value of the currency diminish as the price of goods and services went sky high? Didn't the same thing occur in the USSR during Perestroika?

None of those countries had a credit and debt culture. In fact in Russia ordinary people never had any access to credit at all. None of those countries had currencies with a history of being well regarded internationally either (although Argentina under Domingo Cavallo as finance minister had managed to maintain a currency peg to the US dollar for a number of years). Their internal collapses happened in relative isolation, so that, as defaulters, they were cut off from international debt financing and the constraints of the bond market.

Money supply expansion or contraction is a net effect, taking into account currency devaluations and the collapse of banking debt. If the negative effect of debt collapse on the money supply outweighs the expansionary effect of currency devaluation, then the net effect is still deflationary.

Instead of paying for goods with wheelbarrows of money, or using stacks of worthless bills as fuel for your fire, you end up with not enough money to go around. This was the case in Russia, where salaries were paid months late, if at all, and in Argentina, where bank deposits were frozen, leaving people with no access to their savings. Barter and an economy of favours develop under those circumstances. In Russian this was referred to as the blat economy (see Alena Ledeneva's work on the subject, if it is still in print).

Is there a distinction in our situation that definitively protects us from the wicked one two punch of economic deflation coupled with hyper-inflation in prices as seen previously in other countries?

There's nothing in our system that protects us, only factors that will make it worse than other countries experienced. They were isolated instances, but this time the whole global system is affected. My view is that we'll see a deflationary deleveraging, followed at some point by hyperinflation, but not any time soon as deflation and depression reinforce each other. That kind of vicious circle doesn't resolve itself quickly.

We will also find goods and services much less affordable as we head into the crisis, although their prices may be lower. It isn't the nominal price that matters, but the price in real terms, adjusted for net changes in the money supply.

Just because prices may appear lower doesn't imply that goods and services become more affordable. Affordability depends on the combination of nominal price and purchasing power, and in a deflation, purchasing power will be falling faster than price. In other words, things will only be cheap for the very few people who still have any money because they cashed out when they had the opportunity. For everyone else, things could be almost impossibly unaffordable at lower nominal prices. For instance I fully expect house prices to fall by 90% on average, but in the absence of credit, the remaining 10% would be harder to come by than 100% is now.

As for relative currency valuations, initially I expect the US dollar to benefit from a flight to safety, as it has already been doing since March. It's typical for people to move back to previous safe havens in a knee-jerk reaction when the rug is pulled out from under their feet. As a long standing global reserve currency, the fate of the US dollar should be quite different from that of the Argentine, Russian or Venezuelan currencies, at least initially.

Longer term is likely to be a different story, but even as the dollar eventually falls, cash will still be king for a while in terms of purchasing power relative to available goods and services domestically. In a world where international trade will break down, the domestic situation will be far more important than relative values internationally.

There is basically no such thing as a safe bank at this point, deposit insurance or no deposit insurance. I suggest holding some cash reserves under your own control and putting the rest into short term treasuries.

Stoneleigh, as a late-comer to this economic pile sheep shit that we find ourselves knee-deep in,I would like to thank you very much for the primer that was reposted on TOD. It clarified things for me, and is greatly appeciated.

Many thanks also to Ilargi,you've altered my mind as no chemical ever could.All the best from Adelaide South Australia.

I ran across a youtube of an English guy calling himself (tongue in cheek) The Modern Mystic. He reminded me of the American detective Columbo. He seems sort of unfocused and disorganized, like Columbo, and very entertaining in a disarming way, but I got the feeling that befuddled waters run deep.

His latest, 'Will it Work', in reference to the latest 'buy into banks' rescue plan, is interesting because he tries to explain the present macro relationship/wrestling match of what is called 'capitalism' and government.

He does such a folksy job it's hard to describe but I'm always looking for unique ways to explain stuff like this to friends and family.

After all, nothing has really worked with them so far, maybe the odd duck approach will succeed.

It depends what kind of bonds you hold. Any kind of high yield bond is not a good idea at all, since chasing yield means chasing risk. I would suggest getting out of corporate bonds quickly, and I would move out of long term treasuries, but not as a matter of urgency. Short term treasuries and cash are the safest repositories of wealth at the moment, as you need access to liquidity while it's still obtainable. Don't trust the banking system with it though.

What about TIPS? I guess if there is deflation, it would not be the best place.

I guess that 250 billion announced this morning to put into the banks is from that 700 billion bailout money, or is it extra? If extra that would make a penny over $4 trillion!

Now, how many monkeys at how many adding machines would it take to count that much money as fast as it is being spent? Wouldn't that be nice to know?

-------------

Well managed to bring the white to the face of dear wife yesterday. Casually mentioned I was going to pick up a couple of 5 gallon jerry cans for gas so, if the need arose suddenly, we had an emergency reserve to pick up our son from the Kollege of Esoteric Knowledge. Normally the mention, of the situation as it is unfolding, brings no great eyewidening but that did.

Ah just heard on CNN that 250 billion is out of the 700 billion, so I guess we would need a few less monkeys. That's good, not needing so many more monkeys I mean there will be a big enough barbering bill for shaving the others bald, so they fit the treasury dress code.

have either of you thought about what we might see if the gold contract market starts to see defaults i.e non-delivery of gold at expiration of said contract. there was a commodities guy on CNBC the other saying that he expects this to happen as there isnt really enough gold to cover the paper contracts and more people are starting to take delivery.

Of course I've read about it. I've long maintained that gold is good if you have the financial space to hold on to it for at the very least two years. And you have to be realistic about that: include job loss, 50% drop in real estate etc., and then see what space you have.

There are huge parties out there, for instance governments and central banks, who hold so much that they have an open invitation to manipulate the market. And I think that's what they will do, or at least the risk is very high.

Dump enough into the market to make the price plunge, buy the same gold back the day after at the much lower price, and count your blessings.

ilargi, that $3.76 trillion, that is a large amount and maybe I am barking up the wrong tree, but if one looks at the 5 year TEDand then looks at the change so far on the TED intraday, it doesn't look like such a big deal, but then I guess the day is still young.

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Gee Ahimsa, didn't you realize that Denninger was a little bit dirty? As well as voting for Bush he is very interested in 'bottoms' these days, but then aren't we all? Judge not ... etc., :)

Karl's ideology clouds his conclusions to his often astute observations.

Take yesterday, he comments that the ECB put a gun to the head of Bernanke and Paulson and forced them to follow "old" Europe's lead in buying stock in banks instead of just hosing them with money. The US had nixed the idea at the Gee7 on Friday. Hank's bankster boyz don't want Any accountability or government say in bank affairs.

Well, the conclusion I draw from that is that if Bernanke and Paulson et al were forced to follow, then they are not in control of the 'playbook' or their own ships.

If the Chinese did this to poor old Bernanke and Paulson, Karl's xenophobia would kick in.

White Anglos from the old country, not so bad, not too much face lost.

hahahah Karl, you're Bushittes have been bitchslaped, you gonna take that lying down?

Stoneleigh, i do wonder though, if Argentina was dependant on credit, then how was the IMF able to squeeze them through predatory lending practices?

I realize that Argentina didn't manufacture a housing bubble. But didn't their problem come from excessive debt to other countries that called their loans through the IMF? And essentially their lines of credit were frozen?

Their problem certainly wasn't that they were too prosperous and productive.

It depends what kind of bonds you hold. Any kind of high yield bond is not a good idea at all, since chasing yield means chasing risk. I would suggest getting out of corporate bonds quickly, and I would move out of long term treasuries, but not as a matter of urgency.